I want to talk about risk management today because of the market correction.
music selection: “Brown Eyed Girl” — Van Morrison
If you are not sleeping well at night during this correction, something is wrong. It is important to build in a risk management system that lets you digest prey properly during corrections.
First of all, are you allocated properly? A raptor has an asset allocation strategy that includes bonds. You aren’t worried in this case about market gyrations as holding to maturity ensures your profit is fixed. Some good closed end bond funds trading in the right range are IQI, NEA, NIO, and EHI. You also want an allocation to “hold forever” dividend growers. Much like bonds, you hold these for the income and are not concerned about the price (unless you are in the market for more shares!) Companies like JNJ, WMT, WFC, and CVX fit the bill here. You also want some insurance companies with strong underwriting history. Insurance is a low beta industry. When the market makes big moves, either up or down, for a day, insurance moves less. The long term trend is up but there is less gut wrenching along the way. AWH, AXS, WRB, and CB are good examples here.
Do you have an exit strategy? You should set your exit strategy the day you buy. Trailing stop losses are a good strategy on anything outside your “hold forever” category. This means you might get stopped out early during corrections of something that still had lots of long term upside, but it ensures you do not take a ruinous loss in the event a major market event. Your stop losses are tied to your position size. You usually set a floor such as “no more than 1% of my portfolio” on each position. Thus a 5% position would have a 20% trailing stop loss. That is a great segway as well. Don’t allocate more than 5% to any one position. Some names are going to get harder during corrections than others. Don’t let it be the one you bet the farm on.
Lastly, a raptor is conscious about how much wealth to keep in the stock market. Some raptors, those who get skittish during corrections, might be better served with off market investments. These can include investing in tax liens, whole life insurance, and rental real estate. My old finance professor during undergrad always said “Daddy always said, ‘bulls and bears both make money but hogs always get slaughtered’.” (It is worth noting that ‘Daddy’ was also a Ph.D professor of finance from west Texas.) That is sage advice. Don’t get greedy at the market trough if you have a need for other types of prey.
Take a moment this morning and review your risk management strategy. Make sure it is solid before the next correction.
Devour your prey raptors!