As I write this in mid September, the market seems headed toward its all-time high. But confidence is plunging. We all know that what goes up must come down, but we don’t know when, or what to do about it. So here are a few ideas:
• The most vulnerable stocks, if there is a decline, are those with no significant dividend. If a stock has a good dividend, and there are many right now even as high as the market is, that is at or around 3 percent. Many companies raised their dividends last year and this year, such as Amgen, Starbucks, Walt Disney and Microsoft. And Apple started to pay one!
The reason that dividend stocks feel less market shock is that when prices go down the effective dividend rate goes up. So the stock becomes a better buy and more investors buy it, driving the price back up to a reasonable level considering the return on investment. But there is no such cushion for stocks that don’t pay a dividend.
Of course there is no guarantee that a company will continue to pay the same dividend. A few years ago bank stocks paid nice dividends, but many stopped when the financial crises hit. And General Motors suspended dividends in 2008 when the bad times hit. But if you have significant gains right now in stocks that do not pay a dividend, it might be a good time to take your profits.
• Consider alternative investments. As the market reaches a high point, real estate is still just coming up from a low point. If you do not need the liquidity of investing in stocks and bonds, some diversification into income producing real estate, particularly residential, can be a good hedge against losing value if the stock market declines.
• If you have a sophisticated financial advisor, consider using stock options to protect your gains. There are a number of different methods that can be employed to protect stock positions. But most depend heavily on your personal tax position. Sometimes it is a good idea to sell stock and take the gains, and replace the potential of continued upside by buying calls, but you pay tax on the gains from the sale of the stock. Sometimes it is a good idea to sell the stock and also sell puts just below the price as the stock sale. That way you take your profit on the stock plus the profit on the sale of the put, but you re-acquire the stock at a lower price if it goes down. And sometimes you can sell calls while still holding the stock, to collect in some premium income but automatically sell the stock if it moves up to the price you would like to sell at. These strategies are not so complicated, but should be followed by someone who knows what he or she is doing.
• A lot of people suggest buying gold at a time like this. I don’t. I’m a follower of the Warren Buffet school that says when you buy a pound of gold and hold it, 10 years from now all you have is a pound of gold. But if you buy stock in Apple, you are likely to have an improved company with wonderful products and enhanced value based on something tangible, not just psychology. Still, just in case, I did buy an exchange traded fund (ETF) called GDX, which is a basket of stocks in the gold mining industry. It hasn’t done all that well, but my idea is that if the market goes down there will be a rush to gold and those companies that produce it will have enhanced value.
• Consider selling stocks and using the proceeds to buy ETFs. These funds are much like mutual funds, but they don’t have the costs to the investors of many mutual funds, and they can be more closely tailored to special segments of the market. There are ETFs on about anything you can think of, countries (I hold them in Japan and Brazil, but no profit yet) banks, particular commodities such as coffee or gold or corn, housing, consumer products, etc.
The reason it is safer to hold EFTs if you fear a market decline is that it is more diversified than any one stock. In a decline a particular company can be hit hard, and if you hold stock in that company you will be hit hard. But if you hold an ETF that has invested in 20 such companies, some might be hit hard but others might do well.
• And finally, there is always the advice to just hang in there and not worry too much. Unfortunately the “buy and hold” strategy has not worked well for the past 10 years. Those that pick carefully, take profits on a regular basis, watch the values of the companies in which they have invested and stay diversified have done better than others. I believe this will continue to be true.
For information about Merv Hecht and more details on the strategies and stocks he writes about in this column, visit his website at DoubleYourYield.com.