One of the biggest problems for investors is that in a vast majority of instances they aren’t given the opportunity by their FBB&A’s to protect capital in the event a stock or the market declines in value.  Investors should be aware of all the options available to protect their capital.

So how can you determine if you really want to have downside investment management techniques applied to your portfolio?   In order for you to draw some conclusions, ask yourself if any of the following questions apply to your situation.

  • When the market declines, do you take your unopened brokerage statement and stick it in a drawer in an attempt to ignore the decline in value of your investments? 
  • Do you think your portfolio is loaded with winners despite the fact they have declined substantially and the market is wrong because your selections are right?
  • Does you anxiety level increase as the market drips lower because you might not achieve your goals and objectives? 

If you have answered yes to any of these simple questions and have more concerns weighing on your mind when the market drifts lower, then you really are an investor seeking some type of downside risk management

What’s interesting about today’s market environment, is that in some instances it is a repeat of the late 1990’s.  I am not talking about a NASDAQ, or a tech bubble. Instead there is the potential for many investors that have had the good fortune to take advantage of the upward track of the market to fall into the trap of sheer complacency. For a true B&H investor that understands the risk of such and has a long-term strategy based on an undeterred goal and objective, complacency isn’t a concern.

However, many investors have a much lower risk tolerance than what they profess. You won’t see it during the current market environment as everything is going up in value, but should we have a substantial move lower the “market is rigged” or “the market is killing me, I’m not going to look” mindset will come out in full force.  This will cause them to sell for substantial losses instead of holding the line or looking to hire an investment manager that will implement a risk management policy for them going forward.

How can I be certain to make that statement?   I can remember meeting with people during the late 90’s to discuss what type of investor they thought they were.  Many professed to be B&H investors and laughed and scoffed at the notion that the market could ever go down.  They were looking for the next stock that could go from $10 to $200.  It was like the “Roaring 20’s” or “Nifty-Fifty” of the 1970’s all over again.  I would then show charts similar to the one below where there would be periods of time (1968-1982) where the market or a particular high quality stock did little or nothing (see the pink line on the chart).  Instead they only focused on the blue line where the stock went substantially higher (1983-1997).

Many investors were clouded by the allure of ever appreciating markets due to the distortion of the NASDAQ going from 1400 in October, 1998 to 2800 by August of 1999 and then subsequently moving to 5000 by March of 2000. Then in March of 2000 the market began to crack.  At first, many of those that I met with in the 1997-1999 time period did not change their tune.  We had a 34% rally on the NASDAQ after the 38% drubbing from March through the middle of May.  Everyone thought the worst was over.  Unfortunately, it was just a temporary reprieve as the market continued lower for the next two years. 

As a market historian I knew that it was always possible for long periods of little or no growth in the market.   Fashionable stocks of one bull market weren’t necessarily the best stocks of the next bull market.   This doesn’t mean you sell the Coke’s, Wal-Mart’s, General Electric’s, etc.  Instead, you have to have a better plan on when to buy and sell them to be a risk adverse investor.

Tom is the Founder of TRG and has been the President and Chief Investment Officer since 2008.