Protect Your Profits Now

I love the big pass play in college football. In fact, one of my fondest football memories is the Andre Woodson to Stevie Johnson touchdown pass to beat Louisville in 2007. Even today, watching that play on YouTube gives me goose bumps. One thing I don’t care for, however, is the “expert” in the stands constantly yelling at the offensive coordinator to “throw the deep ball!” As much as I love them, those are low-percentage plays that are prone to incompletions or, worse, interceptions. They add risk to the team’s goals to score and win and should only be employed within the overall game plan.

My investing hero, Warren Buffett, also loves college football, mostly in the form of his Nebraska Cornhuskers. As usual, he found a lesson about wealth building from football when he said, “To really profit from stocks and build wealth over time, investors must avoid costly mistakes that shrink their portfolio balances, just as a football team that wants to boost their odds of winning must avoid fumbling the ball away, throwing an interception, or taking a bad penalty at a bad time.” One costly mistake he refers to is taking on too much risk. Here’s an example of how investors sometimes mistakenly take more risk than they intend:

• Because of the 10-year Bull market, if you had invested $100,000 in September, 2009 in a portfolio balanced 60% in stock mutual funds and 40% in bond mutual funds, you would now have $265,840.
• Your portfolio mix, though, would now be allocated at 78% stock mutual funds and 22% bond mutual funds.
• The second portfolio is much riskier than the first. Here’s how much:
  • Over the last 10 years, the second portfolio had 34% more volatility, ups and downs, than the first;
  • Over the last 10 years, the second portfolio would decrease 46% more than the first when the stock market declined.

Here’s why we should care about this increased volatility and downside risk:

When a portfolio of $100,000 declines by 10%, it is then worth $90,000. In order to regain it’s original value, it must increase by 11.1%. The climb back is steeper than the original decline. More important, a portfolio, in general, will grow at a higher rate if the swings from high to low are smaller – although we all know past performance is no guarantee of future results.

How to reduce risk in your portfolio – take some of your profits:

We regularly rebalance our clients’ portfolios to make sure they remain invested among investment types likes stocks, bonds, international stocks, etc. in a way that supports their individual timeline and circumstances. In other words, when the stock market rises and a client’s portfolio now has more money in stock mutual funds than we believe is appropriate for them, we shift some of that profit. We sell a portion of those funds and purchase other types of investment assets that now have a lower amount than we think is appropriate. You’ve heard of Buy Low, Sell High, right? This is the very definition of that strategy.

So, listen to Warren Buffett rather than the drunk fan calling for the deep ball, and avoid the costly mistake of too much risk in your portfolio. Ten years of a rising stock market means gains and profit but now may be a good time to evaluate your portfolio and try and avoid the costly interception at the wrong time.

Steve Byars, CFP®