3 Tips to Avoid Getting Sick on the Stock Market Roller Coaster

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It’s that time again — the time when clients call their financial advisers with panic in their voices asking, “Is this the correction? Should we sell everything?” The stock market’s daily gyrations — up, down and sideways — have outperformed a salsa dancer’s hips. On Thursday, just one day after the market had its best day of 2014, it had its worst day of the year. And on Friday, it fell again, capping its worst week since May 2012.

Since the 2008 crash, U.S. stocks have, overall, performed very well. During 2013, you didn’t need to be a good stock picker to make big profits. You could close your eyes, put all your money in just one investment — such as an SP 500 (^GPSC) index fund — and end the year with a 30 percent gain. I’m of the opinion those days of easy gains are over. I’ve been saying so for quite a while and have been managing my clients’ brokerage and individual retirement accounts accordingly.

Don’t get me wrong, I’m still bullish on U.S. stocks over the long term and still think stocks could end the year slightly positive. But for investors who can’t bear to see the balance on their monthly statement lower than the previous month’s, I offer three strategies to get you to the end of the wild ride without throwing up.

1. Sell Some Stocks

You most likely have stocks in your portfolio that have run up in price since you purchased them. Now is as good time as any to turn paper gains into real gains by selling some winners. If you think the market is going to tumble further, you’ll want cash on hand to buy more stocks at low prices when the dust settles. That’s what I did during 2008 and 2009. Just like I go through my closet once a year and throw out clothes that I’ll never wear again, I went through my portfolio and sold stocks that either didn’t have growth potential or didn’t generate dividends, and used the cash to replace them with high-quality, dividend-paying stocks when they dropped to bargain prices. If you not sure which of your stocks to keep and which to sell, consult a financial adviser.

A variation on the selling stocks theme is to place stop-loss orders on your holdings. That way if the market turns around and heads back up, you don’t sell your stocks too early. But if the market starts to seriously tank, you’re you have an autopilot order in place to get you out of various equities at prices that are still higher than what you paid for them. It takes only a few minutes to set up stop-loss orders in your online account if you manage your own money.

2. Sell Call Options on Your Stock

If your savings is invested in mutual funds, the call options strategy isn’t available to you. But if you own individual stocks or exchange-traded funds, you can sell call options and generate income. The strategy is referred to as “covered call writing.”

Let’s say I own 100 shares of a popular tech company’s stock that is trading at $100 per share. I already have a 30 percent unrealized gain on the stock, which I purchased more than a year ago. I could either sell the stock today for a 30 percent gain or I could sell a call option that expires one month from now. (Shorter and longer periods are available.) By selling that call option, I am obligated to sell my stock at $100 a share anytime between now and when the option expires, should the call option buyer exercise his right to buy my stock from me. In exchange, I receive $360 in my account today.

The $360 is real money. I can take it out and spend it or reinvest it. At the end of 30 days, either I will have sold my 100 shares of stock at $100 a share or I will still own my stock should the market price be lower than $100 per share. In either case that $360 is mine to keep.

A common practice of covered call writers is to sell call options on the same stock and generate income every month. This strategy is similar to when you buy an investment property and rent it out for monthly income. Landlords understand that the price of the house or apartment may go down before it goes back up, but as long as they are renting it out for income, they can tolerate changes in appraised values. If you already own stocks in your portfolio, this strategy allows you to generate ongoing income from your asset until you sell it.

You can learn to write covered calls on your own, but many investors — due to lack of time or interest — prefer to outsource this function to a money manager. I’m one of the few female money managers in the country who specializes in this strategy, but a growing number of financial advisers are adding this service to their practice. You just need to find them and make sure they are experienced.

3. Reallocate Your Portfolio and Diversify Among Asset Classes

Some analysts believe that relative to other countries, U.S stocks are overvalued. However, there are bargains to be had in international developed and emerging markets. If you want to buy low and sell high, one way to do it is to identify securities that are undervalued. A low-cost and easy way to invest in international stocks is to purchase shares in ETFs that holds stock in many companies in whatever country or region you desire. The prices of many emerging market ETFs have been pummeled by fears of declining global economic growth and the strong U.S. dollar. The same goes with certain developed European country ETFs. Although these investments are risky in the short term as the global economy could weaken and political unrest deepen, over the long term they could benefit many investors.

If you are afraid of stocks, I wouldn’t suggest sticking all your money in bonds, because when the Federal Reserve Board begins raising interest rates (probably in the first half of 2015), bond prices in your portfolio will likely decrease. If you can’t hold the bonds until maturity because you need access to cash, you might end up having to sell them for less than you paid.

Before we began working together, many of my clients weren’t aware that there are other ways to invest money besides stocks, bonds and real estate. Other frequently-purchased asset classes include commodity ETFs, real estate investment trusts, and master limited partnerships. When you invest in the stock market, you are not limited to investing in only U.S. stocks. A plethora of publicly held security types are available to round out a portfolio, add diversification, and reduce volatility.

To generate a return on your investment, you must take risk. For most investors, that means riding out the inevitable ups and down of the market. And if you are patient over the long term, you’ll slowly build wealth. But if you want to minimize the impact of the down times to your financial (and emotional) health, consider following one or more of the three strategies above.

The information contained herein is strictly for educational and illustrative purposes, providing commentary, analysis, opinions, and recommendations and should not be considered investment advice for any specific subscriber or portfolio or an offer to sell or a solicitation to buy any security.

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