Forbes- 3 Ways to Avoid Going Off a Stock Market Cliff With the Buy-And-Hold Herd

8/10/2019 Forbes- 3 Ways to Avoid Going Off a Stock Market Cliff With the Buy-And-Hold Herd

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22/10/2014 3 Ways To Avoid Going Off A Stock Market Cliff With The Buy-And-Hold Herd - Forbes

www.forbes.com/si tes/janetnovack/2014/10/21/3-ways-to-avoid-going-off-a-stock-market-cl iff-wi th- the-buy-and-hold-herd/pr int/

harder as the market heads down. In fact, recent research from

Morningstarhas shown that the average mutual fund generates higher returns

than the individual investors in the funds themselves earn.

One reason for the discrepancy: human psychology. Few people have the

discipline to execute a true buy-and-hold strategy. They get too excited and

buy into late-stage bull markets and get frightened when the market falls,

bailing out at what ends up to be the near bottom of a bear market.

But what if an investor were a model of self-discipline? My own research

confirms that investors who followed Bogles advice to the letter would

perform spectacularly during periods of low volatility like we witnessed in the

1980s and 1990s. But you may be surprised by what else I learned: The

pattern breaks down as volatility picks up as it has in recent years.

I ran some numbers myself back in 2011and reran them recently. I compared

the performance since 1979 of a buy-and-hold Bogle adherent to that of an

investor who sold off Vanguards 500 index fund during significant marketcorrections, then bought the fund back once the stock market regained

momentum. I found that the latter investor the one who probably slept

better at night during the big stock market corrections garnered higher

returns than the investor who stuck with Bogles strategy. Mr. Sleepwells

portfolio did lag a bit during the great bull market of 1982 through 1999, but

it more than made up the lost ground in the volatile markets that followed.

This research has bolstered my sense that, at the very least, more investors

should have a plan in place to defend against big market corrections. Your

strategy doesnt have to be the one I would choose. But its wise to have one

ideally one that you and your financial advisor set in place long before the

market tanks.

If youve never talked with your financial advisor about a rainy-day plan, here

are three worth exploring.

Method 1: Buy-and-sell.If you look up and see a bowling ball falling out of

the window youre standing under, will you brace yourself and hope for the

best? No. Youll step out of the way. This is the essence of what I call the buy-and-sell strategy.

At month end, the S&P 500 closed below its 200-day moving average only 12

times in the period between 1979 and 2013. This signal, it turns out, has been

the equivalent of a bowling ball falling out of a window. Its also an easy

number to check the 200-day moving average is freely available on any

number of financial data websites. So I check the moving average at the end of
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each month, and when the index is 2% or lower than its 200-day average, I

take the hint and step out of the way by shifting my clients assets to money

market accounts.

When the S&P 500 moves 2% or more above the 200-day moving average

again, I shift back into the equity market.

The table below shows how well this strategy has worked over the past 35

years. Here I assume that I funded two portfolios with an initial investment

slug of $25,000 in 1979, then reinvested dividends at month end. One of the

portfolios passively invested in the Vanguard S&P 500 Index Fund (VFINX);

the other invested in the same fund, but used the indexs relationship to the

200-day moving average as a sell signal.

Looking at this table as a chart, the trend comes through loud and clear (note

especially the two lines starting in 1999 each time the blue line plunges, the

orange line remains flat; when the blue line advances, the orange line at least

keeps up). The final result: Our buy-and-sell investor garnered an 11.7%

average annual return over the 35-year period, beating the 10.3% return for

the Bogle investor by 1.4 percentage points.
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This test, you might object, is not realistic. Most people invest a little every

month rather than investing a single, large slug its called dollar-cost

averaging. So I ran the numbers on investing $100 per month and found that

the results looked very similar:

The graph version of this table also looks much the same as the first. The buy-

and-hold line is ahead of the buy-and-sell during the low-volatility secular bull

market, but the buy-and-sell pulls further and further ahead as volatility picks
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up:

This is a strategy that any do-it-yourself investor can understand. But like any

investment strategy, it has its weaknesses. If you are implementing this

strategy in a taxable account, for instance, selling stocks for a gain will trigger

a capital gains tax bill. Also, the idea of following this strategy absolutely,

getting entirely in and entirely out of the stock market, can produce its own

anxieties, leading to inaction. Its harder to pull off than it seems.

So enlist the help of an active investment manager, with a proven bear market

track record, who can help navigate these issues. Yes, youll pay a fee to themanager for his or her help usually 1% of assets under management. But

even after paying that 1% fee per year, youd have outperformed a passive buy-

and-hold investor by an average of 0.6% annually since 1979.

Method 2: Asset class balancing. In our example above, weve made a

black-and-white choice either stocks or cash. But some expertsprefer more

of a gray strategy one that mixes stocks and bonds together in a single

portfolio according to a predetermined proportion, then makes sure that the

proportion stays the same by periodic rebalancing.

Heres how to set it up. Determine a target allocation between stocks and

bonds. Most experts recommend a 50-50 or 75-25 split, depending on your

own risk profile (50-50 for more risk-averse investors, 75-25 for less). Once

youve decided on a proper split, allocate your portfolio according to those

values.

Now, every year, you assess the relative size of each of your allocation baskets.

If stocks have been on a tear, you may start the year with a 50 % stock

allocation, but end it with 60 % in equities. At this time, you take profits on
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part of your stock portfolio and plow those profits into the bond market so that

your actual allocation again meets your target allocation of 50-50 stocks-

bonds.

If the stock market falls during the next quarter, the allocation shifts again.

Lets say your portfolio falls to just 40% stocks. In this case, you would use

dividends and interest payments to buy stocks until your actual allocation

returned to your target allocation.

This strategy has the advantages of being simple to execute, dampening excess

equity market volatility and enforcing the discipline of buying low and selling

high.

There are, however, a few problems with it. You should note that

diversification is not the same as protection. Asset reallocation schemes like

this one will cushion your portfolio from equity market falls, but at the

expense of returns (because not all of your portfolio is exposed to equity

market gains). You should also note that the portion of the portfolio allocatedto equities is completely unprotected. Seeing the equity portion of your

portfolio soaked in red is not the best recipe for a good nights sleep,

regardless of whether your portfolio as a whole is cushioned thanks to bond

exposure.

Method 3: Hedge against a bear market and the IRS. The

problem with selling in a taxable account is that the investment taxes you face

from equity sales can be larger than the losses caused in a minor stock market

correction. So based on tax advice given by his accountant, an investor may

avoid selling stock investments even if he thinks his stocks are overpriced and

the bull market is over.

So consider hedging strategies. They can be a cost-effective and tax-

effective substitute for investment liquidation during bear markets.

Some investors succeed using options to hedge. My weapon of choice for

hedging stock portfolios is the ProShares Short S&P 500 ETF (Sym: SH). This

is an exchange-traded fund that normally rises in value when the market

plunges. It can be purchased in any type of brokerage account. Its expenseratio is reasonable. It performed well in the market collapseof 2008. (Note:

When the market crashed, the ETFs value went up albeit not in exact

inverse proportion to the markets fall. Be aware that the way these

instruments are constructed means that short ETFs do not perform exactly

the way most investors expect them to. Again, heres a tool that is worth

discussing with a good financial advisor.)
http://www.forbes.com/sites/janetnovack/2013/09/20/6-pointed-questions-to-ask-before-hiring-a-financial-advisor/http://online.wsj.com/news/articles/SB10001424052702304543904577394261225920548http://ycharts.com/companies/SH/chart/#/?securities=include:true,id:SH,,id:%5ESPX,include:true&calcs=include:true,id:price,,&zoom=custom&startDate=1%2F1%2F2007&endDate=3%2F31%2F2009&format=indexed&recessions=false&chartView=&splitType=single&scaleType=linear&stockListId=&stockListSymbol=http://intelligentoptioninvestor.blogspot.com/2013/09/options-for-fully-valued-market.html


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This article is available online at: http://onforb.es/1wsxQye 2014 Forbes.com LLC All Rights Reserv ed

Markets drop your net worth doesnt have to.Since the dot-com

bust, one thing has been very obvious to even the most casual observer:

Markets drop. By my count, they have done so every third year or so over the

last century.

Theres much to admire about Jack Bogle. But hes wrong about buy-and-

hold. You owe it to yourself and your portfolio not to join in his passive-

investing choir. Today, all the major U.S. indices are below their 200-daymoving averages. Whether you sell stocks, use an asset-rebalance strategy, or

deploy some sort of hedge protection is up to you and your financial advisor.

What are you going to do?

Kenneth G. Winans is a veteran investment managerbased in Novato, Calif.

The Best Investment Advice Of All Time
http://www.forbes.com/pictures/mjd45eggmg/advice-from-the-worlds-top-market-minds-4/http://www.winansinvestments.com/about.shtmlhttp://blogs.forbes.com/people/kenwinans/http://onforb.es/1wsxQye

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Forbes- 3 Ways to Avoid Going Off a Stock Market Cliff With the Buy-And-Hold Herd