Make Sure You’ve Updated Your ‘Stock Insurance’ Policy


You’ve probably worked out by now that we’re bullish on this market.

We’ve had this view for over a year. Things didn’t look too good at first when we put our neck on the line.

But we stuck with it. We know it’s tough to time the market, but unlike the mainstream dinosaurs, we believe it’s crucial to be an active investor.

And because we believe it’s crucial to be active, we also believe you should look at ‘insuring’ your share portfolio after a strong rally.

With the main Aussie stock index up 15.5% since last August, it now makes sense to look at ‘stock insurance‘…

Before we go on, we’ll make one thing clear: we’re still banking on stocks going higher. And if you think talk is cheap, we’ll point out that we have more stocks on our recommended buy list than we’ve had in more than two years.

So as we say, we’re putting our neck and reputation on the line by going all-in with this stock market.

However, we’ve been in this game a long time. We’re not dumb enough to think that stocks will keep going up in a straight line. That never happens. Yesterday you saw the S&P/ASX 200 fall 18 points.

And when we see stories like this in the Age…

‘Economic spending levels are reaching similar proportions to those typically seen before major financial crises, prompting warnings that over-investment could lead to a significant correction.

‘And Australia, as a major commodities exporter, could be one of the most at risk, according to a new report from credit rating agency Standard & Poor’s.

‘S&P singled out China as the biggest risk factor…’

…we’ll admit we get a bit edgy.

That’s why when we see stocks rally hard and fast, we start looking around for ideas for you to protect the gains you’ve built in recent months.

We Do This and So Should You

The good news is you’ve got a few options. The first option is the obvious – sell your stocks.

Now, this could be famous last words, but we don’t advise that option. And it’s not a strategy we’re personally using.

Your second option is something we’ve banged on about for nearly two years. That is to allocate your wealth across different asset classes. For instance, a few dividend-paying shares, gold, silver, cash, term deposits, fixed interest, and small-cap growth stocks.

That’s our personal strategy, we’re more than happy with it, and we actively suggest you put a similar plan in place if you haven’t already done so.

The way it works for us is that once we buy an asset we rarely sell it. Rather than selling, what we tend to do is use current cash flow to change the weighting of assets in our investment portfolio. E.g. in recent months we haven’t added to our cash exposure; as the cash flows in it is quickly invested in stocks and gold.

There’s a third option. It’s to use what we call ‘stock insurance’. There are a few ways you can do this. One way is to use exchange traded options.

We won’t go into this in too much detail because once we start going into ‘calls’ and ‘puts’ we could be here all day. It’s complicated to learn, but once you get the hang of it, it can be an effective way to protect your wealth, grow your investments, and even provide a reliable income.

But we’ll leave options there for now.

How to Short Sell the Market Without Short Selling the Market

Another option with ‘stock insurance’ is to short sell stocks. That is, if you think the stock market is overpriced, you can short sell a stock (or the index), which means betting on prices falling. If you’re right and the share price falls, you stand to profit.

Like options, short selling has its own set of risks. And it’s not for everyone. But if you’re a serious investor and you want the chance to make money in any market condition, then you should at least look at adding short selling to your repertoire.

But there is one more option. It has the best elements of short selling (profiting from falling shares) without the need to short sell.

We’re talking about the Betashares Australian Equities Bear Hedge Fund [ASX: BEAR]. It’s an exchange traded fund (ETF) that trades on the Australian Securities Exchange. It allows you to buy and sell the ETF just as you would any other share.

The difference with this ETF is that it performs inversely to the broader market. If the stock market goes up the BEAR ETF goes down, and vice versa.

We can best show you by using this chart:

Source: CMC Markets Stockbroking

The BEAR ETF is the blue line. The S&P/ASX 200 is the pink line. You can see that as the stock market has taken off in recent months the BEAR ETF has fallen.

So if you want a way to protect some of your investment portfolio, the BEAR ETF is a pretty good way to hedge your portfolio, even if it’s just for a short time.

It means you don’t have to sell any of your share portfolio, which could trigger capital gains tax or cause you to miss out on dividends.

Of course, the BEAR ETF may not be a perfect hedge for you. For instance, if your shares fall more than the BEAR ETF rises. But even so, it’s something to think about.

Australian stocks are at a two-year high, and the index is only a couple of hundred points from a four-year high. So while we’re banking on stocks continuing to rise this year, it makes complete sense to start thinking about ways you can insure your share portfolio if the worst happens and the market hits another rough patch.


PS. If you want to keep track of the latest things we’re reading and brief commentary on events that happen through the day, check out our Google+ page here. Whenever we come across a story we think could interest you we post a link and a brief comment. Check it out, we think you’ll find it useful.

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