I just finished reading former Goldman Sachs CEO Lloyd Blankfein’s memoir, Streetwise: Getting to and Through Goldman Sachs.
Chapter 22 is titled “Don’t Get Dead.” It refers to the idea that no business should act in such a way that a calamity could threaten the company’s existence.
It’s one of the reasons Goldman Sachs was so much healthier than many of the other large financial institutions during the global financial crisis.
Investors should have the same mindset.
I’ve been emphasizing this to subscribers of my Oxford Income Letter and my VIP Trading Services.
We’re in a bull market. Lots of stocks are going up. Many folks have profit fever.
But as I’ve reminded readers, the profits will take care of themselves. Managing risk is the most important thing you can do to improve your investing results.
Here are a few tips to ensure you don’t get dead (financially).
1. Don’t invest more than you can afford to lose.
If you invest more than you can afford to lose, the stress will lead to poor results. You’ll take profits too quickly or avoid taking a loss because it’s too painful (even though you should take it before it gets worse).
It’s human nature, and everyone, including me, has done it.
Before you enter the trade, imagine if it were to go to zero − or, in the case of a stock that likely won’t go to zero quickly, imagine it getting cut in half. Paint a worst-case scenario.
Then position size accordingly so that if it does happen, your life won’t be upended.
2. Diversify across institutions.
Hold your money in several financial institutions. That way, if something happens to one of them, not all of your money will be locked up while the mess gets sorted out.
During the financial crisis, I was using an instrument similar to a money market fund as my savings account. It invested in Treasurys that matured in seven days. Super conservative.
When the spit hit the fan in 2008, my broker locked up these funds. For over a year, I didn’t know whether I would be made whole. I eventually was, but I didn’t have access to the money for that entire period.
Today, my cash, stocks, mutual funds, etc., are in various institutions. If one goes down and I suffer losses, at least I’ll have money and investments available at other brokers.
It’s unlikely that a behemoth like Schwab or Vanguard is going to collapse. Then again, it was unlikely that Lehman Brothers and Bear Stearns were going to collapse too.
3. Use trailing stops.
One strategy for ensuring your losses don’t get too big is to set a trailing stop. (If you’re unfamiliar with the concept of a stop, I cover the basics here.)
The Oxford Club usually uses a 25% trailing stop.
That means you set a stop 25% below your entry price, and as the stock rises, the stop goes along with it. If it’s a trading position and not a long-term investment, you may consider tightening the stop as the stock rises to protect your profits.
Don’t Miss the Good Times
Things will happen in the markets. There will be bear markets, crashes, and crises.
However, the market goes up over the long term, and you have to be in the market to take advantage of it. If you get blown up because you didn’t manage your risk, you won’t be in for the good times.
What other steps do you take so you don’t get dead? Let me know in the comments below.