All in or all out is a dangerous play, no matter how the saying goes. Better to combine a little rebalancing with some smart hedging strategies, writes MoneyShow's Howard R. Gold, also of The Independent Agenda.
So, you think the market has had a big run, is ripe for a correction, and that the six months starting now are usually a rocky time for stocks. What should you do?
“Sell in May and go away” isn’t about timing or outguessing the market—a fool’s errand if there ever was one. It’s really about limiting risk.
According to the Stock Trader’s Almanac, from 1950 to 2011 the Dow Jones Industrial Average gained on average 7.5% over the six months from November through April, but only 0.3% from May through October. And the S&P 500 fell 10% from its April peak last year, 19% in 2011, and 16% in 2010. That’s a tiny statistical sample, but it shows late spring and summer can be rough on your portfolio.
Most investors would be perfectly OK just holding on and heading for the beach. But if you’re more active and want to protect some of your gains, there are some sensible, conservative strategies you can use to hedge against a market correction. There also are some pretty bad ones, which I’ll get to later.
1. Rebalance twice a year. Instead of rebalancing in January, you can use the calendar to your advantage and buy or sell to reach your target allocations on May Day and Halloween.
Let’s say your target stock allocation is 50% of your portfolio, and the market’s gains have pushed equities to 55% of your assets. Well, just exchange that excess 5% in stocks into short-term bonds and cash now, and adjust it again on October 31, if necessary.
2. Lock in some gains. If particular stocks or ETFs you hold have posted huge advances over the past few months, why not put some of your profits in the bank?
I’m not suggesting selling all your big winners—that’s often a very bad idea. But selling, say, 10% to 20% of your position in a stock or ETF that has had a great run is a prudent way to protect against sudden corrections.
3. Lighten up on your losers. The market’s big move has pushed a lot of stocks higher, but you still may be under water on some. If this is the best they can do, maybe now’s the time to put them out of their misery. That will lower your equity exposure while concentrating it in stronger stocks and sectors.
4. Set trailing stop-losses. Let’s say you have some winners but you want to let them run. Set a percentage below the current price of a stock or ETF—say, 10%. As the stock moves up, the price at which a sale is triggered will rise with it.
Stop-loss orders are free until a sale is actually executed, and then you pay commissions. But use stop losses only for the shares you want to sell.
NEXT: Simple Options Strategies to Hedge Your Risk