Editor’s Note: Kristin has been tasked with reporting on the Fed’s big decision this afternoon, so she is taking a break from reading the Mailbag. Be sure to check out her special report in tomorrow’s Wealthy Retirement.
For today, we’re sharing an exclusive article from The Oxford Club’s Chief Investment Strategist Alexander Green that our friends at Investment U thought you’d like to read. Enjoy!
The recent volatility in stocks has many market participants perplexed.
Some feel this is the beginning of a new bear market. Others believe it is just a normal and much-needed correction in an ongoing bull market.
But it would be a big mistake to bet heavily either way.
No one ever knows what the market will do next. So the wisest course of action is to always hedge your bets… and follow our Escape Hatch Strategy.
The Oxford Club operates from the real-world premise that economic growth, interest rates, Fed policy, commodity prices, currency values and short-term market movements cannot be accurately and consistently forecasted.
Acknowledging this – as all the great investors have, from Benjamin Graham to Peter Lynch to Warren Buffett – is the foundation of intelligent investing.
The key is not to react emotionally to market movements but to prepare for them in advance.
The first element of our Escape Hatch Strategy is your asset allocation. How you divide your money up among stocks, bonds, Treasury inflation-protected securities and other asset classes is your single most important investment decision, responsible for as much as 90% of your long-term total return. (The balance is determined by your security selection, investment costs and taxes.)
If you have too much invested in stocks, you won’t be able to withstand the inevitable downturns. If you have too little, you won’t reach your long-term financial goals.
That’s why The Oxford Club recommends that you have 60% of your portfolio in equities.
The second element of our Escape Hatch Strategy is position-sizing. You should never invest more than 4% of your stock portfolio in a single stock. (It may grow to be much more than 4% of your portfolio eventually. But don’t start with more than 4% initially.) This ensures that you never have too much in any single security.
The third part is our trailing stop strategy. This gives you unlimited upside potential with strictly limited downside risk. We never hold on to a stock that has fallen 25% from its high or our original entry price. It’s our ironclad sell discipline, protecting both our principal and our profits.
As you can see, we have strict criteria for what and how much we buy – and strict criteria for when we sell. Anyone without a well-defined buy and sell discipline is simply flying by the seat of their pants. And that rarely leads to outperformance.
The Escape Hatch Strategy gives you plenty of upside potential. (After all, The Hulbert Financial Digest has ranked our Communiqué among the handful of best-performing investment letters in the nation for the last 14 years.) But here’s how it also keeps you safe…
When you have 60% of your portfolio in stocks, you take advantage of the superior long-term returns available in equities. But when the inevitable correction or bear market shows up – as they always do eventually – you have far less volatility (and fewer sleepless nights) than someone fully invested in stocks.
But there are other benefits. Here’s what happens when you combine our trailing stops with our 4% position-sizing strategy. Even if you take the maximum loss (25%) on the maximum position size (4%), your stock portfolio is worth only 1% less, since 25% of 4% is 1%.
Of course, by using our asset allocation strategy, you have only 60% of your investment capital in stocks. So your true maximum loss amounts to just six-tenths of 1% of your portfolio’s total value (since 60% of 1% is 0.6%).
Bear in mind, this is your worst-case scenario. The maximum loss on the maximum position size using our maximum recommended stock allocation would result in your portfolio being worth 0.6% less.
In a serious bear market or correction, of course, it is likely that you will stop out of several stocks in a short period of time. So the losses may mount. You will be taking profits too, however. For example, we recently stopped out of Union Pacific (NYSE: UNP) in our Oxford Trading Portfolio with a 168% gain. That would offset a number of losses of 25% or less.
The real test of our Escape Hatch Strategy was the financial crisis of 2008 to 2009. That bear market started in earnest in the summer of 2008. By October, we had stopped out of all 44 positions in our Oxford Trading Portfolio.
We took profits in many of those positions and losses in others. But the average return was 28% on those 44 recommendations. Not bad for a year when the S&P 500 declined 36%, one of the worst years since the Great Depression.
In fact, the market didn’t stop falling until the second week of March 2009. The drop between October 2008 and the bottom in 2009 was over 50%. Yet by using our Escape Hatch Strategy, we dodged it entirely.
I recently created a special Escape Hatch Portfolio, made up of investments designed to prosper in good times and bad. It contains food companies, drug companies, healthcare companies, medical technology firms, diversified holding companies and bonds that are immune to future interest-rate tightening.
Available exclusively to my Oxford Communiqué subscribers, the Escape Hatch Portfolio offers both a high margin of safety and excellent upside potential – and is designed to be used in conjunction with our asset allocation model, position-sizing strategy and trailing stops.
Our Escape Hatch Portfolio is a vastly superior alternative to running to the temporary safety of cash and thereby missing the recovery when it comes. As it inevitably will.
In the meantime, you can relax and let the latest craziness in the market play out. After all, you don’t have to worry.
You’re using an Escape Hatch Strategy.
P.S. Alex’s new Escape Hatch Portfolio has been in the works for months – but its release couldn’t have come at a more crucial time. As Alex noted in a recent column, what’s happening in our economy is unlike anything we’ve ever seen. Our national debt is bigger than our GDP… the Fed has held rates at zero for nearly seven years. This situation isn’t sustainable. Alex’s advice? “Govern your portfolio accordingly.”
To get access to the Escape Hatch Portfolio – which contains 15 carefully selected stocks, funds and holding companies that are less cyclical than most, offering a higher margin of safety – click here.