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posted on 21 January 2017

Investors: How Not To Lose Everything And Die Broke

by William Patalon, Money Morning

Money Morning Article of the Week

We've just been through a very healthy post-election rally that pushed the S&P 500 up a bit more than 6%, as of this week.


The history buffs out there, like me, will note the S&P 500's "Trump Bump" was a little less than twice as powerful as the 3.7% shot in the arm Franklin D. Roosevelt's election dealt the index, but a bit less than half as potent as the ripping 13.29% rocket ride Herbert Hoover's victory "catalyzed" on the S&P 500 between his election in 1928 and his swearing-in.

But… we all know how that rally ultimately played out for investors of Hoover's day.

At his inauguration on March 4, 1929, "the Great Engineer," as Hoover was called, could rightly boast of huge market gains. And of course barely eight months later, by Oct. 29, the U.S. stock market was a smoking ruin, closing the door forever on the Roaring 20s and lifting the curtain on the Great Depression.

Now, I'm not saying we're in for a repeat performance. Not at all. But I am conscious of the history, and as a dyed-in-the-wool contrarian, I'm inclined to prepare for the worst, especially if the good times are rolling.

Besides, I agree 100% with our Chief Investment Strategist, Keith Fitz-Gerald, when he says that, "Chance favors the prepared mind."

So even if it's the farthest thing from your mind, there's no time like right now to take in a few of what we here at Money Map Press like to call "Downturn Lessons." They'll not only save you a lot of heartache when the weather changes, but you'll be in a much better position to make money at a time when nearly everyone else is losing it.

So let me share them with you.

Downturn Lesson No. 1: Don't Run for Cover

Investors are lousy at predicting short-term market trends. Indeed, as I hinted just a moment ago, if you sell out in a bad market and miss the rebound (or even miss a handful of the "best" market days), your long-term returns plummet.

If you invested $10,000 in the S&P 500 at the start of 1995 - and stayed fully invested to the end of 2014 - your average annual return would have been 9.85%… and your stake would have grown to $65,453, JPMorgan Asset Management said in its 2015 "Guide to Retirement."

But if you missed just the market's 10 best days, your average annual return would plunge to 6.1% - and your portfolio would only be worth $32,665. In other words, missing those few days where stocks were stock cut your gains in half.

It gets worse.

Miss the 60 best days (you cash out, run to the sideline, and only reinvest after the market outlook becomes "clear"… meaning you dozed through most of the bull-market rebound), and your portfolio actually records an average annual loss of 3.84%.

That $10,000 you invested? It's now worth $4,570 - after two decades in the market.

Build yourself a nice "foundation" of investments with a long-term horizon. And augment that by looking for special-situation opportunities. That's a one-two punch that will really put you on Easy Street in the long run.

Downturn Lesson No. 2: Keep Your Plan Updated

Everyone should have a financial plan - a written document that outlines your financial goals… and details how you expect to achieve them. Be sure to assess whether you're behind, ahead, or right on schedule. Do a new assessment each quarter.

Downturn Lesson No. 3: Reassess Your Tolerance for Risk

During the "dot-com" boom, lots of historically conservative investors were making so much money that they ceased to be concerned that this was being done by using increasingly risky stocks. (I have a story to share on this… in a few minutes.)

When that dot-com boom turned into the "dot-bomb" bust, lots of folks were positively horrified by the shellacking they took. A physical therapist friend of mine was so badly stung that he can't retire - and he continues to work today - in his late 60s, even though his health problems have left him virtually crippled and visually impaired.

Don't get stung like that.

Take the time to assess your risk tolerance. And be honest. How much volatility can you really stand? How will you feel if the big gainers you're sitting on fall back, eradicating a chunk of those gains? Do you have the emotional makeup to ride through a whipsaw market? What about a full-blown crash? Finally, has your risk tolerance changed - due to the change in your age, financial situation, new goals, or experience in the markets?

Once you've answered those questions, make any changes you feel you need to make in order to feel more secure in such a potentially uncertain environment.

Downturn Lesson No. 4: Ditch Your Dogs

No, not your pets.

In fact, during times of intense stress, studies show that pets can help you relax, and actually promote wellness. (And I love animals…)

I'm talking about ditching your "doggy" investments - the stocks, funds, or other holdings that have cratered in value or have done nothing during this powerful bull market. By dumping those laggards, you help yourself in a bunch of ways.

First, you reduce the odds for still-steeper losses. You raise capital for new profit opportunities and even create a "margin of safety" in your holdings. And if you put that cash to work in a better-performing investment, you also rev up your returns.

Downturn Lesson No. 5: Harvest Some Tax Write-offs

If you have losses in some of your mutual funds, stocks, or ETFs, you can save some money on your taxes but still stay invested pretty much as you were by executing what's known as a "tax swap."

You lock in the capital losses by dumping the losing positions and purchasing positions in companies in similar industries or funds with similar investment mandates. If you do this, make sure to beware of the "wash-sale rule," which can disallow the tax break if you invest the sale proceeds in a "substantially identical" investment within 30 days of the sale (before or after).

Let's say you have a stock that's a loser, but that you still like. And you worry it could pop during the 30-day stretch that you're "out" of it.

Here's a neat trick a mentor of mine taught me years ago.

Buy an equal position in the same stock… then wait 31 days or more and sell the first position. If the stock moves in the interim, you'll go along for the ride. Otherwise, you've booked a loss that can offset other gains, but are still in line to profit if the stock rallies. And you're in at a lower cost basis than the original position. Talk to your accountant before you make any of these moves.

Downturn Lesson No. 6: Switch to an "Accumulate" Strategy

Thanks to Wall Street's sell-side analyst community (and some popular investment shows on certain cable channels), we're trained to think in terms of "Buy, Sell, or Hold" when it comes to stocks.

But add another term to your vocabulary: "Accumulate." Don't be afraid to "Accumulate" shares of companies whose long-term prospects you really like. By "Accumulate," I'm saying to establish a base holding of those stocks - and then to add to those holdings with a few dollars here and a few there whenever those shares sell off. Thanks to deregulation and the emergence of online brokers, it's no longer cost-prohibitive to do this.

And you can also use so-called "Direct Stock Purchase Plans" and dividend reinvestment plans (DRIPs). If you find that you have a few bucks, throw that money into some stocks. You'll thank yourself later. (Indeed, years later you'll honor yourself with a blowout party… trust me.)

Downturn Lesson No. 7: Streamline and Simplify

This holds true for your investments, for your finances in general, and for your life. In your portfolio, take a careful look at your holdings. And ask yourself…

Do you have too many stocks, bonds, and funds to follow?

Can you still articulate the reason for owning them?

Does the reason you bought each position still hold true?

Consider culling any holdings that no longer fit your objectives. Look at your finances, too.

Do you have a plethora of credit cards? Get rid of the ones you really don't need. If you don't have them available, you can't add on a bunch of high-interest-rate debt - not a benefit in a market downturn. Better still, get rid of the excess cards and find a low-rate card that offers some feature that fits with your lifestyle - such as travel benefits, gasoline discounts, or bonus bucks.

Downturn Lesson No. 8: Slash Expenses, Reduce Debt

This one is simple: Get lean and mean.

Look at your household budget and excise things that really aren't needed. Get rid of high-rate debt. Cut expenses in your investments, as well.

For instance, if you have a lot of funds, take a look at their expense ratios. If you find a fund or funds where that ratio is really high, consider a cheaper alternative (especially if the fund you now hold has high expenses and is also a lackluster performer). And if you're holding stocks on "margin" - which lots of folks get tempted to do in a raging bull market - get rid of it now while the market is at a peak.

Don't wait for the market to skid… "Margin calls" from your broker during a gentle correction are nagging, annoying, and embarrassing. Margin calls from your broker during a market free fall are ruinous. A round of margin calls can - and will - inflict a wound from which you'll never, ever recover.

Downturn Lesson No. 9: Boost Your Savings

A money manager shared this strategy with me during a story interview years ago, and it's one of my favorites. When there's a market sell-off, the natural urge - as we said earlier - is to sell. If you want to do something concrete to blunt that urge, offset some of the near-term losses you're experiencing in the stock market by boosting your savings.

Downturn Lesson No. 10: Work Longer

Rochester, N.Y., where I spent eight years of my journalism career, is a bastion of "old money" thanks to the all the wealth created in the formative years of such once-dominant firms as Eastman Kodak Co. (NYSE: KODK), Xerox Corp. (NYSE: XRX) and Bausch & Lomb Inc. All that old money meant Rochester was also a bastion of money managers, trust departments, and family offices. I got to know a lot of those folks, got to see how they worked, how they created and held onto wealth, and the miscues some of them made.

Some were really smart, though. Like Anthony Gallea, coauthor of our 1998 best-seller "Contrarian Investing: How to Buy and Sell When Others Won't and Make Money Doing It."

Tony's specialty was "lump-sum rollouts" - the big cash "buyouts" companies were using in the 1990s and 2000s to reduce head count and cut costs. Indeed, he even authored a book on that - "The Lump Sum Handbook: Investment and Tax Strategies for a Secure Retirement."

Folks would come to Tony saying, in effect, "Hey, we've got this windfall, and now we want to retire." With some of those folks, the numbers didn't "work." Tony's advice: work three more years - and boost your savings.

Rates were much higher then, of course, but let me share what he would sometimes tell clients, just so you get an idea. If you can get even 8% a year on your total portfolio, you can boost your total holdings by about 25% - a meaningful "nest egg" increase that can make the difference between a difficult retirement… and a dream one.

I always found that to be pretty shrewd thinking. In these times, sometimes working a few more years is a sound strategy.

Downturn Lesson No. 11: Bank Your Raise

As I mentioned earlier, I used this one myself back during my days as a business journalist - before I became an investment guru.

During the last five of the eight years I worked for Gannett Newspapers, I lived on my base salary - and diverted the after-tax results of the raises I received into stocks and mutual funds. In other words, I continued to live on what I'd been earning before - pretending, in effect, that there was no raise.

It sounds almost too simple to mention here, but it worked well.

Raises in the newspaper business were never all that big, but when my wife and I bought our first house back in 2000, the investment proceeds from those raises (and the capital appreciation on what those investments had generated) made for a hefty down payment. For you, banking raises or bonuses or other income windfalls could be used to finance your emergency fund or to create a "war chest" of cash that you'll deploy if the market turns turtle and creates a bunch of buying opportunities.

Downturn Lesson No. 12: Beware of Scammers

Scam artists are opportunists - and they do their jobs well.

When a particular investment heats up, these financial con artists come out in droves to offer something that's even hotter (or, at least, that appears to be). There's usually some "risk-free" feature to it.

I'll bet you've seen some of this yourself.

Think about gold. When the "yellow metal" zoomed starting in late 2007, suddenly all these "we'll-buy-your-old-gold" places opened up - even in the vacant stores inside the mall in my hometown. There were ads on the radio and on television. Offers in the mail. Some were real. Others were scams. But scam artists are often even more effective during times of turmoil.

They offer struggling investors "a way out" of their problems with "can't-miss" profit plays - and then skip town once you've paid them. Be sure to thoroughly investigate anything you're looking at. As corny as it sounds, remember the investment aphorism that "if it sounds too good to be true, it probably is."

And be sure to report any scam attempts - don't just blow them off. If you report them, law-enforcement agencies can track what's happening. You might end up saving a friend, family member, or coworker from a ruinous loss.

By the way - this is a "Baker's Dozen." That means you get an "extra" lesson.

Downturn Lesson No. 13: Buy Some "Crash Insurance"

If you're worried the stock market is getting rocky, make that rockiness work in your favor. Pick up some shares of the iPath S&P 500 VIX Futures ETN (NYSE Arca: VXX), which tracks the Chicago Board Options Exchange Market Volatility Index, also known as "The VIX." Often referred to as the "fear gauge" or the "fear index," the VIX represents one measure of expected volatility in the stock market in the 30 days to come.

In other words, the VIX often soars in value when investors get scared - as they do when markets decline. And because VXX tracks this fear gauge, this "Crash Insurance" soars in value when markets decline. This isn't a long-term holding - and you don't want to "load up" (overinvest). But as a "hedge" that will gain when markets fall, it could be a nice addition to your portfolio.

Editor's note: These lessons will help you navigate any market crisis or downturn; Bill is a proven strategist. But he's also the World's Greatest Stock Picker. In fact, since he first published Private Briefing in 2011, he's recommended more than 217 double- and triple-digit peak gain winners for his readers. You can learn how to get his daily Private Briefings for yourself right here.

Follow Bill on Facebook and Twitter.

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