Portfolio Protection for Crazy Times

So I’m watching Elon Musk getting interviewed on a live podcast last Thursday night, when the guy starts smoking marijuana. On YouTube, in front of millions of viewers.

No, this isn’t a story from The Onion.

The billionaire founder of electric car maker Tesla (NSDQ: TSLA) was puffing on a joint, in a wide-ranging discussion with comedian Joe Rogan. Musk also drank whiskey and got quite emotive about his current business woes.

Welcome to Crazytown, USA.

Investors these days find themselves in uncharted waters. I needn’t belabor how the current occupant of the White House shatters norms on a daily basis.

As summer gives way to autumn, investors face a dangerous period.

Stocks are overvalued, bitterly contested midterm elections are heating up, the global trade war rages on, interest rates are rising, inflation is mounting, corporate debt is a ticking time bomb, emerging market currencies are melting down, the Trump administration is mired in dysfunction, and… the CEOs of multi-billion-dollar corporations are getting stoned on the Internet.

It’s time to take proactive action, to protect your portfolio.

The markets are high. Really high.

Pictured is Mr. Musk, taking one toke over the line.

Tesla stock is dropping amid missed production goals, C-Suite defections, and Musk’s aborted attempts to take the company private. The entrepreneur’s managerial fitness is now under scrutiny by shareholders, as well as by the SEC.

As the latter half of 2018 devolves into comedic lunacy, you should also question the fitness of financial markets.

We’re officially in the longest bull market of all time. But the stock market, bond market, and real estate market are all in bubbles.

When a crash comes, none of these asset classes will be immune. Don’t let your retirement savings go up in smoke.

Consider these six defensive moves. They offer portfolio protection, but they also keep you in the game.

1) Use Stop Losses When Buying Stocks

One of the most widely used devices for limiting the level of loss from a dropping stock is to place a stop-loss order with your broker. Using this order, the trader will pre-set the value based on the maximum loss the investor is willing to tolerate.

If the last price drops below this fixed value, the stop loss automatically becomes a market order and gets triggered. As soon as the price falls below the stop level, the position is closed at the current market price, which prevents any additional losses.

A trailing stop and a regular stop loss appear similar as they equally provide protection of your capital should a stock’s price begin to move against you, but that is where their similarities end.

The “trailing stop” provides an advantage over a conventional stop loss because it’s more flexible. It allows the trader to continue protecting his capital if the price drops, but when the price increases, the trailing feature becomes active, enabling an eventual protection of profit while still reducing the risk to capital.

Over time, the trailing stop will self-adjust, shifting from minimizing losses to protecting profits as the price reaches new highs.

2) Diversify Among Stocks and Sectors

Don’t put all of your eggs in one basket. Also be sure to diversify across sectors.

Investors often punish themselves as much as the market does. Despite the compelling case to diversify, many investors hold portfolios with assets concentrated in relatively few holdings. This common failure has its roots in lack of knowledge and just plain laziness.

3) Spread Your Money Among Several Asset Classes

Don’t just stick to components of the S&P 500 or the Dow Jones Industrial Average. Spread your portfolio among value, small-cap, large-cap, growth and dividend stocks.

4) Spread Your Investments Geographically

Don’t simply focus on specific country or regional funds, or on emerging markets. The best course of action is to diversify throughout the world through international index funds.

5) Set A Specific Retirement Date

It’s important to have a specific date in mind for when you plan to retire. This should be based on multiple factors, not just your investment portfolio.

If you enjoy your job, would you prefer to keep working (and saving) a little longer? It’s tough to get back into the working world once you’ve left it behind.

Are you slated to get a defined-benefit pension from your job? Are you fully vested already? If so, you may not need to make significant changes in your investments.

When are you eligible for full Social Security benefits? This varies depending on when you were born. If it was in 1960 or later, you will have to wait until age 67. If you start to collect your benefits earlier, your monthly payments will always be lower than if you had waited. Then make an honest assessment of your future spending needs.

6) Create a Plan for Drawing Living Expenses in Retirement

As a general rule, you should withdraw cash from taxable accounts first. Later on, focus on tax-deferred accounts such as traditional Individual Retirement Accounts (IRAs) and annuities.

Leave accounts with tax-free with­drawals for last. An example of such an account is the Roth IRA, which allows taxpayers, subject to certain income lim­its, to save for retirement while allowing the savings to grow tax-free. Taxes are paid on contributions, but withdrawals, subject to certain rules, are not taxed at all.

Early in your retirement, convert­ing currently taxable assets to spending money makes sense because little or no additional tax likely will be due.

First, take dividend income and any mutual-fund distributions in cash instead of reinvesting them. You pay tax on these payouts even if you reinvest them, so this step won’t cost you anything.

Next, sell investments with no cost basis or the highest basis and therefore no or low taxable gain.

Assets with no cost basis include money funds and bank CDs as well as Treasury bills and various types of bonds held to maturity. Bond funds likely carry a high basis compared with your sale price, and therefore low tax liability.

Ideally, you’ll be more passive in tak­ing long-term gains and more active in “harvesting” your tax losses.

Questions or comments? I’d love to hear from you: mailbag@investingdaily.com

John Persinos is the managing editor of Investing Daily.