Will Rogers once said, “Don’t gamble, take all of your savings and buy a good stock and hold it ‘til it goes up, then sell it. If it don’t go up don’t buy it.”
That is some of the best advice on stock investing that I have ever heard. Clint Eastwood said, “If you want a guarantee, buy a toaster.”
People frequently ask me if there are ways that they can protect their portfolio from losses. The answer is yes, there are many ways you can protect a portfolio from losses, the method you choose to protect your portfolio depends on your individual situation, and there is no “one size fits all” simple strategy.
Risk tolerance is very much an individual matter that depends on factors like, age, income and net worth. In general terms, older people with substantial nest eggs built up will have less tolerance for risk. Younger people who have more time on their side and may not need income from their portfolio may be able to ride out periods of market volatility and decline.
Put options can be useful for controlling risk. Buying a put option is kind of like buying insurance on your house; it costs money, and you hope you don’t really need it. Investors with stock holdings can buy puts on their individual stocks, or use a process where you determine which index your portfolio is most closely correlated to and buy put options on that index.
The “beta” of your portfolio to an index, like the S&P 500 is a number that will tell you how closely your portfolio tracks the S&P 500 index. If your holdings mirror the index closely, you can buy puts on the index for protection instead if protecting each individual position.
Another situation that is fairly common are investors who hold what we call concentrated equity positions. They may have worked for one company for a long period of time and have a substantial portion of their net worth tied up in one stock and want to continue to hold the stock but protect some or all of their holdings.
You can purchase puts on that stock or create a position known as a “collar,” where you sell some call options to finance the purchase of the put options. With a collar, you limit your upside gain, but protect your downside.
Remember, if you want a guarantee, buy and toaster, and if it don’t go up, don’t buy it.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.