Riding the Wave for Financial Success

This post Riding the Wave for Financial Success appeared first on Daily Reckoning.

In a column last week, I mentioned that my daughter was participating in the USA Surfing Championships. Well, I’m happy to say that she made the final for her age group and got invited to join the USA junior Olympic development team as well.

Of course, not everything went perfectly.

During the early part of her final heat, a massive set of waves came through and detonated on her and another competitor. My daughter had to duck under wave after wave, losing a lot of time and a lot of energy in the process.

Good thing she was wearing a leash – a rubber cord that connects a rider’s ankle to a surfboard.

In the earlier days of surfing, there was no such thing. Your board just rolled and tumbled to shore, often getting crushed on a reef or rocks along the way.

Of course, plenty of old timers – and some younger traditionalists – continue to surf without leashes.

There are some functional advantages, especially if you enjoy moving up and down your board a lot. And there are also some philosophical reasons as well.

In fact, you may hear some people grumbling that “the leash is what ruined surfing” or simply referring to such devices as “kook cords.”

The idea is that back in the day, before leashes, you had to be a competent swimmer and very aware of your own abilities out in the water.

As someone who occasionally surfs smaller waves (and longer boards) without a leash, I can tell you there is some merit to the argument. And yes, there is an investing point to this story…

False Sense of Security

Your whole mentality shifts when you aren’t wearing a leash.

For starters, you aren’t simply going for every wave in sight because there will be consequences to blowing a takeoff, falling, or having something else go wrong.

You are also a lot more careful about how you jump off your board and where you point it. The last thing you want is a new ding or to accidentally hit another surfer.

And when a number of surfers are all swimming after their boards, the entire lineup changes and opens up a bit more. You might say the better surfers get more waves while the less adept spend more time swimming away from where the waves are actually breaking.

In short: Leashes are like surfing’s great equalizer, but they can also breed a false sense of security.

Is anyone really safer wearing a leash?

I’m not sure.

Boards can still travel five or ten feet in any direction, which is plenty of room to hit someone or something else.

Rank beginners feel far more empowered to put themselves into situations they probably can’t swim out of.

People can paddle into more waves, which amplifies overcrowding.

And if anything, all these surfers are worrying far less about where their boards may end up going.

Today’s Financial Markets

I’m telling you all this because today’s financial markets feel much the same way – most investors and financial institutions are basking in a safety net created by easy money and yet serious dangers are still out there. 

Think about it …

When dotcom stocks crashed, the Federal Reserve came swooping in with low interest rates to help smooth over those (much deserved) losses.

When real estate speculators got wiped out in the subsequent bubble, here came the Fed yet again, pushing rates even lower.

The ensuing financial crisis? Same thing. Bailouts for banks and reckless institutions.

Now we’re hearing the Fed talk about the possibility of lowering rates once again.

Of course, the risk of drowning is still out there.

Just ask anyone who’s ever had a leash snap in sizable surf.

Suddenly that floating life preserver is no longer connected to you and the shore looks a lot farther away than it did two minutes earlier!

We may be approaching that day when the leash is simply stretched too far. When everyone has been lulled into a sense of complacency. And when the lifeguards are powerless to do anything more.

Knowing “How to Swim” in Our Financial World

So enjoy the waves. But make sure you know how to swim!

As I’ve explained many times, dividend stocks inherently carry some downside protection during tough markets.

In addition, you should also have other tools at the ready.

Meanwhile, you should also take stop loss orders, which tell your broker to sell your shares should they reach a predetermined price level.

Now, I do NOT recommend stops for your long-term, income-generating investments, provided you believe the company is strong and the dividend is reasonably secure.

That’s because if you’re constantly getting stopped out of positions, you will lose the current income, which is the real benefit of buying and holding dividend stocks.

However, choppy markets call for defensive measures when it comes to your shorter-term positions, especially if capital appreciation is the main goal.

You can also employ stops in your profitable positions as a way to lock-in gains in the event of a market decline. Simply raise your stop loss as the profits pile up.

Another thing to consider: Inverse ETFs, which hold a basket of investments are designed to go up when markets are heading down.

Example: An inverse ETF focused on Dow stocks should go UP when the Dow goes DOWN by roughly the same amount.

There are also double and triple inverse ETFs. They can be expected to go up two to three times as much as the Dow or another index goes down.

If you’re an income investor holding dividend stocks, inverse ETFs can help you hedge your portfolio against an imminent market drop without having to lose ownership or miss out on any dividend payments.

That’s not to say there aren’t some disadvantages with inverse ETFs:

First, you must allocate some of your investment dollars to the inverse ETFs, thus giving up some income for the protection.

Second, if the market rises substantially, your inverse positions will lose money (or at least offset the gains in your “long” positions).

Third, because of the way they’re constructed, inverse ETFs can drift away from their benchmark over time. And this is especially true of the double and triple leveraged versions.

In other words, if you hold them in your account for a long time, you may find that they gradually move away from the “mirrored” performance you expected.

But for short-term purposes, they are still a valid option. In fact, they can work really well with proper timing.

I know from experience. I recommended a double inverse Dow ETF — the UltraShort Dow30 ProShares ETF (DXD) — to my readers back in August 2008. And on September 30, 2008 … I recommended doubling their stake in the DXD for additional downside protection.

What happened next? The Dow plunged about 2,400 points!

When I recommended closing out the hedges at the end of 2008, I tracked gains of 65.4 percent and 43.7 percent, respectively.

That’s powerful protection, indeed!

And there are still additional, more advanced steps you can consider, too – including several strategies that involve options.

Plus, there are the original “investment leashes” – precious metals like gold and silver.

The bottom line? The seas might look really smooth so far this summer, but it never hurts to prepare for that rogue set somewhere out on the horizon.

To a richer life,

Nilus Mattive

— Nilus Mattive
Editor, The Rich Life Roadmap

The post Riding the Wave for Financial Success appeared first on Daily Reckoning.