Bill, a new subscriber, recently wrote us this note:Dear Friends: Protecting Your Stock Portfolio Gains First, he wants an "exit strategy" to protect the gains he has realized following our stock. This is a good question. A shrewd investor always has a Plan B in place to limit losses if his investment begins to move the wrong way. One exit strategy is to set a trailing-stop order of 25%. [A stop loss is an order you give your broker to sell your stock if its price dips below a certain point. For example, if you buy a stock at $40 and set a 25% stop loss, your broker will sell it the moment it hits $32 (8 points, or 25% less than $40, the price you paid for it). A trailing stop loss means that the stop loss is triggered not by the price you bought it at, but by its highest price. Thus, if the $40 stock goes to $50 and then drops, your broker will sell it at $37.50, which is 25% less than $50.] Using a trailing stop loss means that, at worst, your stock portfolio won't decline more than 25%. When your stocks go up, as ours have done, then your maximum loss is less than 25%. In a rising market such as we've experienced, it's quite possible to protect not just your original investment, but also your profits with this strategy. I know what you are thinking: You don't want to lose 25% or even 20% or 15%. But you can't have zero downside with stocks. My first rule of investing ("Never, ever lose money")-which I've recently discovered is Warren Buffett's first rule-is managed by doing all the other things I am about to tell you. So that answers the first question about an exit strategy for stocks. Bill's second question is, "How do I protect the investments I already have?" We don't know what other investments Bill has, but let's assume he has some equity in his home, some other stocks, and some cash. He's worried that the economy and/or the stock market might take another nosedive-"or worse." The classic way to protect against market fluctuations is by diversification. Diversification means that you don't invest in just a single type of investments. You spread your bets out, as it were, so that if one part of your investment portfolio goes down, other parts that may hold steady or even go up can protect you. I'm a big believer in diversification because I've learned from experience that I'm not infallible or clairvoyant. As much as I know about my own industry, I don't know enough to predict the performance of the companies I own, let alone companies I don't. And as for other industries? I'd be kidding myself to think my investments were certainties. Diversifying, like setting stop losses, is a statement of humility. I do it because I realize I can't be 100% sure. Diversification works like insurance. There is a cost to it (getting lower yields), but I'm happy to pay that cost because I simply refuse to ever become poorer. When most financial advisors talk about diversification, they mean a mix of bonds and stocks. That will give you some protection in normal times, but with most of the Western world in bankruptcy, this kind of diversification is not nearly enough. In fact, having a portfolio of only stocks and bonds over the past 20 years hasn't been effective. It may be even less effective in the next 10 years. Here are the ways I have diversified my wealth: Bonds are generally less risky than stocks because they are loans, not equity investments. The profits of the company you have lent money to can go down, but your bonds are still good so long as the company doesn't declare bankruptcy. [Bonds, also known as "fixed-income securities" are investments in which investors loan money to either corporate or government entities for set periods of time. In return for borrowing this money, these entities pay bond holders interest.] I have always had a good portion of my money in bonds. Historically, about two to three times what I had in stocks. I used to get about 5% tax-free on my municipal bonds. That amounted to a pre-tax return of about 7.5% (in my tax maximum bracket). The difference between 7.5% with bonds and 9% (the long-term average return of stocks) was only 1.5%. I was willing to give that up for the safety. Today I'm not buying many bonds because I have plenty and also because I really like the kind of stocks the investment advisors are recommending. So the percentage of my overall portfolio in stocks, compared to bonds, is rising. If you have no bonds at all, you should consider buying some. Go slowly and be careful. I have a considerable amount of money invested in gold (and now platinum) coins. I like coins for many reasons. They are tangible, portable, transportable, and private. In other words, they are perfect if things get "much worse," as Bill from above worries they might. My coins have already tripled in value, so I can't feel certain they will continue to appreciate. But that's not why I own them. I own them because I know they will always have value, and I will always be able to spend them. I've put them in my escape-and-start-over bucket. (Refer to Chapter One: The Secret of the Golden Buckets.) And that's where they will stay. If you have no gold coins, you should buy some, even at today's high prices. Another excellent way to diversify today is by investing in rental real estate. I've been recommending this because, like precious metals, real estate is tangible. But better than coins, the right kind of real estate will give you a lifetime of income. I've been investing in rental real estate for about 30 years, and, except for my first investment, I've never lost money on it. I stopped investing in 2006 because it was easy to see we were in a bubble. And I got back into it in 2010 because it was easy to see that it would be very profitable. Despite the idiocy of millions who "never saw it coming," real estate is the simplest and easiest investment in the world. And there is one more reason I like real estate. It can be very profitable. That's because you can leverage it with financing. I've probably earned more than 20% per year on my real estate over the years. It's made me many millions of dollars. If you have no real estate, I recommend it. This will likely be the best time in your life to get into it. But the window won't stay open forever. (=. I will also be discussing investing in rental real estate as part of a whole series in the Wealth Builders Club.) Finally, you don't need to be rich to play this game. You need a minimum of $10,000 and a modicum of common sense. The fifth element of my diversification is cash. I always keep a stockpile of cash around-not for emergencies (a dumb idea in my opinion) but for opportunities. Having a store of cash has allowed me to jump into the real estate market after it tanked. When disaster hits, cash is king. Those five are the main components of my diversification: stocks, bonds, gold, rental real estate, and cash. For most investors, that should be enough to stay safe. But for my subscribers who are better heeled and more adventurous, I will mention some additional ventures. I regularly invest in start-up businesses. This is an especially important tactic for anyone who is seriously worried about an economic collapse. When I buy into private businesses, I don't take long shots. I invest almost exclusively in businesses that:
Another way I hedge my bets is by investing overseas. I own businesses and real estate in probably a dozen countries. In every case but one I have trusted overseas partners. This isn't as "simple" as local real estate, but it can be very profitable. A third way I have diversified is by investing in collectibles. Collectibles have the benefits of being tangible, portable, and private. Most importantly, investing in collectibles is fun. And finally, I'm using an options strategy. I sell put options on high-quality stocks, and I use covered calls. I'm generating over 10% a year from this strategy, which has no correlation to my other investments. In fact, this works even better in hard economic times because volatility will rise, increasing my returns. As you can see, I am extremely diversified in terms of the kinds of investments I've made. Again, I do this not because I am positive each of these sectors will perform especially well, but because I'm honest enough to admit that I'm not certain. Besides all of these investment strategies, I take full advantage of any legal strategies I can to safeguard my wealth from legal attacks. I do that by using a variety of trusts and limited partnerships. And finally, I do whatever I can to safely minimize my taxes. In my tax bracket, saving $1 is like earning $1.50. But I'm not a nut when it comes to avoiding taxes. By that I mean I won't spend a lot of time on it and I won't take any risks, especially with the IRS. I've been an advisor to tax-avoidance publications for more than 20 years, and I know first-hand many of the top experts in the field. There is nothing that any of them has ever shown me or told me that has tempted me to try to fool the taxman. If you are considering aggressive (i.e., possibly illegal) tax strategies, I advise you to put your energy into making money. It's easier and a lot less risky. My first rule of investing is never lose money. That may sound like an impossible feat, but I can assure you from personal experience that it can be done. Using trailing stop losses, diversification, legal structures, and tax minimization strategies will go a long way to protecting your wealth. But to achieve my overall goal ofgrowing richer every day, I do one more thing that I'll be recommending to you: I keep earning money, even when I don't need to, by creating multiple income streams. Having multiple income streams is the ultimate assurance that you will always be wealthy. I have worked very hard over the years to establish at least a half- dozen revenue streams that bring me lots of income every month. They all began small, but they all grew over time. Any one of them can keep paying for my lifestyle burn rate (see Chapter 8: What's Your Magic Number). So even if all of my assets somehow disappeared, I'd still be a wealthy guy. I know this may be a lot to digest right now-especially if you are a novice investor. That's okay. Through the Wealth Builders Club I will give you a blueprint for everything I've laid out here. For the time being start with what you have. Make sure you understand how to set trailing stop losses on the stocks you've been buying. And be sure to reread Chapter One: The Secret of the Golden Buckets before you do. Each thing you do will make it easier for you to sleep at night, knowing your wealth will continue to grow. By Mark Ford |
Friday, June 05, 2015
How to Safeguard the Wealth You Are Building (Secret 9)
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