This week’s dip presents another opportunity for investors who have been itching to put more money in the stock market. There have been several pullbacks this year since the market bottomed but all of them have been shallow. Investors waiting for a really big sell-off have been disappointed and they may be yet again.
Buying a certain set dollar amount of securities over a period of time, usually several months, can be a profitable strategy that can reduce the average cost of a particular investment. It’s called dollar-cost averaging and works best in declining markets. However, it can work well in market corrections or dips like we have had this year.
So far, we have had three pullbacks since the March lows ranging from 4% to 7%. Many pundits are waiting for a bigger correction on the order of 10-15% but so far the markets refuse to oblige. First, it was feared that the summer would bring a correction when volumes were low and investors were on vacation. When instead, we were greeted by a summer rally, pundits re-grouped and put off the correction until now, the September-October period, when markets traditionally perform their worst.
We may still have that long-awaited pullback. Statistics are on the side of those who expect it. Rarely do markets go up (or down) in a straight line. There is no question that markets are extended so we should be prepared for the inevitable no matter when it occurs.
So how do you play the pullback? Of course, you could go to cash, but if this dip turns out to be shallow, you will have shot yourself in the foot. Not only will you incur brokerage fees for selling plus capital gains on your winnings, but then you will be forced to go right back into the market and re-build positions. I suggest leaving that that tactic to the day traders.
However, there are a variety of ways you can hedge your portfolio. You can sell some of your winnings and reallocate that money to cash, bonds or some other asset class. Professional portfolio managers do this often. It’s called “portfolio re-balancing”. Another strategy would be to buy put options on either the market or on your individual stocks. The prices of “puts” go up when the underlying optioned security declines. Please note, prices go the other way when your securities go up. One could also buy inverse exchange traded funds as a hedge. These funds function like put options rising when the markets or sectors go down and vice versa. Inverse ETFs have received a lot of bad press recently. Their detractors claim that speculators use them to manipulate markets, which I find hard to believe. Inverse ETFs are valuable tools that can protect your investments, especially in uncertain times like today.
“I have a better idea,” said the owner of a convenience store I frequent in Columbia County who plays the market, “just take the hit, watch it go down and buy some more. I’ve been doing it all year and it works just fine.”
Good advice. Maybe he should be writing this column.