Owning something that will increase in value precisely at the time the market dives sounds awesome, doesn’t it? Options contracts can do just that. They really are fascinating instruments. Options are the most direct and precise way to counter downside in the stock market of all the things I have written about here.
They are not, however, free. Unfortunately, to use them to great effect, you have to be right about which way the market is going to go, how far it will move and the time frame in which the move occurs. That is asking a lot. If the market goes the wrong way or not far enough or not at the right time, the options don’t help. In taxable accounts, it can be even harder to net a big enough profit because short-term gains and ordinary income is the usual result of a position that pays.
Options and the use of the other items I have mentioned all suffer from the same basic problem. The focus has turned away from a sound long-term plan and toward trying to lessen the effect of a market downturn—as though downturns are something to fear rather than something to expect.
The whole exercise of finding “where to invest now” is, in fact, market timing, but some clients won’t see it that way. They aren’t bailing out to sit in cash. They are just adjusting. They don’t see the bet on market behavior their change implies.
Back in late February of 2009, I got an e-mail from a client about an “adjustment” with this sentence in it: “I know none of us can predict the future, but depression or not, the stocks will continue to go down in the next few months.” (Emphasis added.)
Classic. He says no one can predict, then he makes a short-term prediction as though it were a sure thing.
As I write this, the S&P 500 is flirting with the traditional bear market threshold, having fallen 20%. If it falls another 20%, mainstream media will cover the markets a lot more and not in a positive way. This will prompt some otherwise calm clients to worry and may make others uncomfortable enough that they forget the tenets of prudent investing. They’ll do much better if you can guide them back to prudence.
Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by Financial Advisor, Financial Planning, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager and Worth magazines. He practices in Melbourne, Fla. You can reach him at [email protected].