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“The bull walks up the stairs. The bear jumps out the window.”
– Wall Street adage
The CNN Fear & Greed Index – my favorite measure of market sentiment – has been on a roller-coaster ride.
The index plunged to “extreme fear” in mid-September.
Then it rebounded to “extreme greed” through most of November before collapsing into “extreme fear” after the announcement of the omicron virus.
As of this writing, it’s bounced back to “greed.”
Such sudden shifts in sentiment over such short periods are particularly treacherous in financial markets. But seasoned investors know that it’s not the sudden shift in market sentiment that matters… It’s how you react that makes all the difference.
Strategies to Crash-Proof Your Portfolio
It’s easy to become complacent when markets have been on a tear since they bottomed in March 2020.
But with volatility across all asset classes growing as we enter 2022, now is an excellent time to think about how to crash-proof your portfolio.
Here are three strategies to do just that…
Strategy No. 1: Set Trailing Stops
Large drawdowns – drops in the value of your investment portfolio – are a fact of investment life. Not even the world’s best investor can escape the pain.
Warren Buffett has endured drawdowns of close to 50% three times: once in the early 1970s, once in 1999 and again during the 2008 financial crisis.
Buffett has warned that if you can’t endure a 50% drawdown in your portfolio, you shouldn’t invest in the stock market.
Of course, Buffett has no choice. He is forced to be a “buy and hold forever” investor because he could never exit his largest holdings without moving the market.
For the rest of us, suffering through massive drawdowns means that Buffett’s advice to “buy and hold forever” quickly morphs into “grin and bear it.”
Luckily, as small investors, we have a massive edge over Buffett… We can sell our holdings.
The Oxford Club has a simple rule: Set stops – generally 25% trailing stops – on all your investments.
Yes, this strategy is more about preserving your capital than “crash-proofing” your portfolio. A 25% trailing stop ensures that you never lose more than 25% of your initial investment and helps lock in some of your profits.
This strategy alone will do wonders for your long-term returns – and psychological health – when a market crash does arrive.
[For more information on how to use trailing stops to increase your Oxford Club returns by up to 6X, check out Chief Investment Strategist Alexander Green and Chief Income Strategist Marc Lichtenfeld’s 2022 Stock Market Fast Track event.]
Strategy No. 2: Consider Inverse ETFs
In the past, I’ve compared exchange-traded funds (ETFs) to Lego blocks. That’s because ETFs allow you to build, brick by brick, a portfolio to fit your specific investment objectives.
An excellent example of just such an ETF strategy is inverse ETFs.
Inverse ETFs are bets against the market. That means they go up when the market goes down.
Say you’re convinced that tech shares are set to crash in 2022.
You can bet against the Nasdaq-100 by buying the ProShares Short QQQ (NYSE: PSQ).
The Nasdaq-100 includes all the large tech names, including Apple (Nasdaq: AAPL), Microsoft (Nasdaq: MSFT) and Amazon (Nasdaq: AMZN). If the index drops 10%, this ETF will rise by the same amount.
There are even leveraged versions of this short bet. For example, invest in the ProShares UltraShort QQQ (NYSE: QID), and when the Nasdaq-100 drops 10%, the fund will jump around 20%.
Finally, the ProShares UltraPro Short QQQ (Nasdaq: SQQQ) offers triple-short exposure. A 10% tumble in the Nasdaq-100 could generate up to 30% returns.
Invest in inverse ETFs at the right time, and you can make more money more quickly during a market crash than you ever did in a bull market.
Strategy No. 3: Bet on “Black Swans”
Popularized by my friend Nassim Nicholas Taleb, a “black swan” is an event that’s rare, high-impact and difficult to predict.
In investing, black swans happen when financial markets fall fast, hard… and unexpectedly. Think of the crash of October 19, 1987, when the Dow dropped 22.6%.
Such sharp falls occur far more often than mainstream financial models predict. A black swan always comes out of the blue.
So what’s the best way to protect your portfolio from black swans?
You could engage in a complex range of options strategies like Taleb does. Or you could buy an ETF that implements an options strategy for you.
Specifically, the Cambria Tail Risk ETF (CBOE: TAIL) invests about 5% of its assets in a portfolio of out-of-the-money put options on the S&P 500. It holds the rest of the assets in 10-year U.S. Treasurys.
Both Treasurys and put options tend to rise during a market crash. And you can expect the Cambria Tail Risk ETF to do the same.
But like any other form of insurance, this protection costs money.
Cambria spends roughly 1% of the fund’s total assets purchasing put options over rolling one-month periods. So this “insurance” costs you about 1% per month.
How has this strategy performed in real life?
In 2021, the S&P 500 gained around 27%.
Over that period, the price of the Cambria Tail Risk ETF fell by 13%.
As the chart above confirms, this ETF trades like the inverse of the S&P 500… except with less downside.
This means that you can expect the Cambria Tail Risk ETF to soar during any market crash.
The bottom line?
Whether it’s short-term market jitters… a full-blown 10% correction… or the start of a 20%-plus bear market… make sure you have a plan to crash-proof your portfolio.
As Jim Rogers, George Soros’ first investment partner, advises, “Look down before you look up.”
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