Baby Boomers – Use Stop Losses to Protect Your Nest Egg

I came across an article on the Motely Fool Web site that advocated against the use of stop losses. There is no doubt that in hindsight using stop losses did affect market returns from 2003 to mid 2007. But we cannot used hind-sight to make investment decisions especially in retirement. You can read the article here – Stop! In the Name of Loss

I understand they are trying to sell their stock picking service, but there is more to it than that. First we need to define our objective and at what point we are in our life. If we are in retirement or close to it we should not be investing in single stock picks unless we are very experienced at it. This is just gambling. If we want to invest our nest egg in the stock market then we need to be in index funds, ETF’s or Mutual Funds that have a broad spread of stocks in them. This cushions us from the shock of a single stock going down.

Second we cannot afford to lose large amounts of money from our nest egg in retirement when we are taking a pension.

It may be okay for someone in their 20’s up to their 50’s even to invest this way. But Baby Boomers cannot afford to take the risk.

What this article shows is a list of stocks some of which made significant returns from 2003 to 2006 during a bull market.

In the article Adobe was bought in January 2003 the beginning of the bull market for about $20 and was still held in November 2006 which was still a bull market. It went to a high of about $35 in early 2004 before dropping to about $25 in mid 2005.

They say we’d be out of Adobe on a 15% stop by May of 2003 and this is correct. They make the case for once the stop has triggered you have no way of getting back in. Why not apply the same criteria used to select the stock in the first place? If it is a good company and they still have long term prospects then use some technical analysis to get back in once you have established the trend is likely to continue. Or in the bull market just select another stock.

Even good stocks can be taken down if there is a general market down-turn. Why go down with it? In 2000-2003 the S&P 500 dropped 40% and included good and bad stocks.

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Just look at the highs and lows in this stock. Even in a bull market this volatility can occur in single stocks and so retirees should not invest in them unless they know what they are doing. Will you be able to sit on the side lines while your profits disappear in mid 2005 or mid 2006? In retirement you’ve got to have a plan in place, not just a prayer and well before that happens.

What about an index fund, mutual fund or an ETF though. Let’s look at ETF’s since they are tradable and are easier to apply stop losses to. Take the SPY. Here if we use a 15% stop we would not be out of the market until around November 2007, near the top of the market for this ETF.

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all charts courtesy of http://bigcharts.marketwatch.com

How does the Adobe stock compare with the SPY ETF in performance. The comparison chart below clearly shows the volatility of Adobe over the much more stable SPY. Okay you only make a 50% return on the SPY compared to 150% on Adobe. But what an emotional ride you have wondering if you will get your money back on three separate occasions. That is not healthy for a retiree believe me. What if you needed the money in mid 2005 or mid 2006?

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We need to remember our objective in retirement is to avoid large losses, preserve our capital against inflation and if we get returns above inflation, thank the Gods for being so good to us. We want to aim for regular and reliable income in retirement and so should not invest in single stocks. But investing in ETF’s and using stop losses is one of the ways to do it, if we want to invest in the stock market.

At the end of the article is the sales pitch. They go on to say that they have been investing for 4 plus years which means they have been investing from 2002 which was the last year of the Dotcom bear market. Then in 2003 the bull market began and they have had the benefit of an up trend through to December 2006. This is great and I have no problem with that. But they mention the average return was 68% compared to 30% for the S&P 500. I hate it when people talk about averages. I would like to see how they performed each month from late 2001 or at least each year. That tells me how they managed to perform during the later part of the bear market. That will tell me how good they are at picking stocks and making profits with no stop losses in place. I’d also like to see their trades to see if they sold any stocks. This would be against their stated investment philosophy. Also how can they declare a profit if they have not sold anything yet since all the stocks are chosen for their valuations and should be held for the long term. So is the 68% a paper profit? Do not believe you have nothing to lose. In retirement you have everything to lose if you do verify their investment track record!

Baby Boomers investing in single stocks is gambling with your nest egg and you should not do it.

Let me state it clearly – in the absence of more sophisticated methods of protecting your nest egg against large losses, stop losses are a must. If you employ a financial planner have them provide you with a written statement of how they would implement stop losses to protect your nest egg.

2 Responses to “Baby Boomers – Use Stop Losses to Protect Your Nest Egg”

  1. […] did affect market returns from 2003 to mid 2007. But we cannot used hind-sight to make investment dehttp://www.protectyournestegginretirement.com/avoid-large-losses/use-stop-lossesFinancial Futures Washington PostWashington Post columnist Martha M. Hamilton was online Tuesday, […]

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