Any investment portfolio is bound to take some lumps in a volatile market place like that experienced by most investors in the last 14 months. During an economic market cycle, market pullbacks and corrections are commonplace and naturally occurring parts of normal market growth. Even so, they can be difficult to stomach and send investors reeling for less volatile asset classes. When the volatility pendulum swings, investors can stay too long in the way of a poorly performing investment. Riding upward growth is euphoric for most investors but the contrary is disproportionately crushing to the psyche while plundering the pocketbook. How do you stop the madness when you’re holding and you should be letting go?
No matter which type of investment you’re holding, whether you’re long or short a position, the potential for loss may be greater than what is necessary. Emotional trading could spell disaster for an investment portfolio and adding a process or some structure to your guidelines may be the remedy to managing emotions that you’re looking for as an investor. While no method is perfect, there is possible merit to attempting to control a losing slide when it happens and the first thing an investor should be is “ready”. Hoping for the best in a market downturn may give you ulcers and lots of sleepless nights so working to find a comfortable strategy for a possible downturn may help you rest a little better. There are several techniques that might be helpful in managing an investment portfolio so that common sense doesn’t become second place to emotion. Let’s take a peek at several of these useful techniques that you or your advisor can employ in managing your hard earned money.
Investors have unique circumstances and goals and each also has a unique risk tolerance. As with any investment account, it’s important to establish an investment objective before getting started. This will help you outline some rules that govern your portfolio. Keeping emotion at bay during the course of investment progress might be to your benefit both mentally and fiscally.
Investment Policy Statement
An investment policy statement (IPS) could be helpful for any investor looking to add some definition to the selection, management and exiting of investment within a portfolio. An IPS makes a contract of sorts between the advisor and the client. It outlines things like fees, objectives, suitability, portfolio management, need for liquidity, and other general guidelines for the governance of the portfolio. This could also include how to handle poorly performing investments held by the investor. In outlining a process for dumping a clunker, the investor should be able to manage expectations and keep emotion under wraps.
A stop loss order is designed to sell a certain security at a predetermined price so as to avoid loss in holding a position beyond the investor’s loss threshold. Once a stop loss order is in place it can be ordered for the “day” or “good till cancel” giving the investor a way to logical parameters instead of emotional chaos. Placing a stop loss order before going on vacation might make your time away from civilization enjoyable if your favorite equity is publishing earnings that are expected to miss by a long shot.
A trailing stop order is very similar to a stop loss order with one small significant caveat – it moves with the price on the way up. Therefore, if a stop loss order is placed today at 15% below today’s current price and the market price rises by 2% on some announcement, my threshold for my stop loss just grew by 2% bringing my total loss to 17% from the price today and not the 15% it was originally. A trailing stop gives the investor the ability to manage, in an accurate percentage, the acceptable loss from the current market price and not a previous mark. This can be particularly useful when a position makes a strong surge over a short period of time.
When managing this type of order, an investor should expect to adjust it periodically, especially in times of enhanced volatility. You don’t want to execute an order that “magically” swings past the order price then back to par for the day. Many investors get burned on days like Aug. 24, 2015. The financial markets opened sharply lower and then rebounded significantly in a single trading session. Many stop loss and trailing stops were triggered that day much to the dismay of your retail investor so use caution. Circuit breakers invoked at 7%, 13% and 20% on the trading floor do not directly correlate to individual investments. Carefully consider whether this strategy is right for you.
Continuous Volatility Parameters
When constructing a portfolio you’ll have a target on your desired return. That desired return will come with an inherent risk. That risk can be measured in any number of ways but standard deviation is a very common one. By continuously measuring standard deviation it’s possible to “take your foot off the gas”, so to speak, when the market heats up. There are many tactical strategies that have been created out of the fires of the financial crisis in 2008 and 2009. The basis for many of those strategies and tactical approaches to managing money is a measure of volatility. Then each takes a systematic approach to moving money whether to cash or more conservative investments.
In all, there are many ways to stave off losses associated with poorly performing investments. Most are effective in one way or another. While each has merit, all should be investigated thoroughly before implementing in your repertoire. Consulting an advisor may help in determining if one of these strategies is right for you and having a mechanism in place to address potential losses could be just the spirit your portfolio needs to be complete.
Matthew Jarrell can be contacted at Retirement Wealth Management Group