Posted By RichC on October 26, 2013
After writing the Liquidity addict post for Friday and speculating that our “irrational exuberance” for stocks has bold investors buying with reckless abandon (CNBC on Friday said margin buying is near all time highs). Concerned? Hmm, yup. I also received a couple of emails from readers who said they were happy, but also worried about the rapid gains in their retirement accounts and wondering what they should do. Well, it’s not easy to predict when this stock bubble will pop, but statistically the recent gains have not corresponded to the economy growing. From my perspective, the stock market can’t continue to rise without real economic growth.
The question is, “what should you do about long term retirement savings?” Should you sell everything and miss out on equity growth and try to time the market in order to get back in again? Probably not … as this is a guess no matter how sophisticated you are. It is difficult enough to put together a long term balanced portfolio in order to have growth throughout ones working career, let alone trying to manage the principal through the ups and downs. So once you’ve committed to a balanced portfolio and are adjusting type of holdings over time (growth vs income as you age), then guessing when to be in and when to be out of the market hardly makes sense. On the other hand, putting new money to work buying additional shares after prices have risen double digits in a half year doesn’t make sense either in my opinion. In fact the odds are that prices won’t continue to rise at the same double digit percentages year after year. In fact there is a greater likelihood share prices will stagnate or pull back due to normal profit taking … then there’s always the possibility of a market correction or surprise event.
So here’s a middle ground option (key word “option”). Consider taking the dollars that you would have used to add additional shares, and instead purchase some downside insurance by buying put options.
You can either use married puts (stock you own) or buy puts on an entire market … or the sector that have had seen the largest gains perhaps? Worst case scenario is that you’ve wasted money on the insurance if the market stagnates … but you can at least sleep at night. If the market drops, the value of your Protective Puts increase if value and offset your equity losses. And finally in the best case scenario, stocks continue to rise, the economy grows and your portfolio holdings offsets your “insurance premium” and then some if the irrational exuberance continues.