Broker Check

Hold’em, Fold’em, Or Skim

Do you remember that famous Kenny Rogers song, “The Gambler” from the late 70’s?“You got to know when to hold ‘em, know when to fold ‘em, know when to walk away and know when to run”. Isn’t this the essence of what we’re always trying to figure out with our investments? When the markets tanked in 2008, we certainly did our share of folding, walking and running. But what about now, with the markets at all-time highs, and a reasonable expectation of positive trending in 2014? For the sake of discussion, let’s assume that the global economies are stabilizing and that we are slowly entering a growth cycle. Do we hold, and make minor portfolio adjustments as we attempt to optimize our returns? Or, do we prepare for a future downturn by selling high, and taking some monies off the table? And if we do, where do we stash the cash, and for how long?

Given that there is no magic strategy and that levels of risk aversion differ amongst clients, the logic here is to “skim” profits in preparation for a significant market correction, and to use this money for living expenses until a recovery is fully in motion.If a “correction” is usually defined as a 10% market drop, (sobering, but hardly serious) how should we define a “significant correction”? To set parameters, the tech bubble and the Sept. 11 attacks resulted in a combined three year market loss of about 40%. (2000-2002 were the only three consecutive years of market loss since the Great Depression) 2008’s debacle handed us another 40% loss. For discussion’s sake, let’s simply define a “significant correction” as a one year market drop of about 20%. Any scenario is possible, but we will assume that a recovery will follow.

If we skim $75,000 for our safety net and invest it in the relatively safe categories of floating- rate bonds and short term investment grade bonds, (caution: bonds can lose value too) we can allow the remainder of our portfolio to fall with the markets, and then to recover without having to “sell low” to fund our living expenses throughout that year.Sounds neat and tidy, doesn’t it? But what if the next shoe doesn’t drop for five or six years, while the markets continue to show solid returns? A conservative investor may find comfort in this long term protective strategy, while the more aggressive investor will become frustrated with the safety net’s low returns. Clearly, a skimming strategy is not for every investor. A more responsive and flexible strategy is to shift equity dollars to fixed income as economic red lights continue to flash, thus providing the required income during the downturn. This is the classic hold ‘em fold ‘em conundrum.

As we review portfolios every quarter, each client’s strategy must adjust to the latest evaluation of economic and market risk, the perceived need to exert control over the investments, and the percentage of the portfolio that must be protected from a significant market correction. My personal opinion is that the markets will continue on a positive track, with relatively minor set-backs as the Fed begins tapering its stimulus programs. With that being said, Kenny Rogers’ character only lost a match, a cigarette, and a swallow of whiskey; our stakes are infinitely higher. Let’s never forget the StoneRidge investment mantra, “Protection first, and growth second.”


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.