The Ten Commandments of Portfolio Protection

We just passed the third anniversary of the start of the pandemic (hooray?), and the uncertainty it caused has yet to settle down. Each of the last three years, in fact, has presented a completely different financial landscape: 2020 felt like the end of the world, 2021 felt like a party, and 2022 felt like a hangover.

It is hard to know what to expect after a string like that. So I decided to compile some perennial investing principles that I use with my clients in good and bad times alike. I came up with ten, as a matter of fact, and am proud to present the following Ten Commandments of portfolio protection:

  1. Make a plan and stick to it!
  2. Maintain an allocation that balances your needs with your risk tolerance.
  3. Use “bucketing” to stretch out your assets.
  4. Use “decision rules” to give your plan flexibility.
  5. Do not try to time the market!
  6. Do not buy or sell stocks based on price.
  7. Do not trade stocks – invest in companies.
  8. Do not bail out!
  9. Do not be afraid of “lazy money.”
  10. Remember that every slump is an opportunity.

1. Make a plan and stick to it!

First and foremost, remember that fidgety investors do not succeed (here is some data on it if you do not believe me). No plan is fool-proof, but you need to pick a lane in order to succeed at all. Analyze, decide, and then commit.

Wondering how to make a good plan in the first place? So glad you asked!

2. Maintain an allocation that balances your needs with your risk tolerance

Your portfolio will be weighted in favor of certain investments over others – say, for example, 55% equities, 35% bonds and 10% cash. But the key is to be intentional about how it is weighted. And be warned: trends or common rules of thumb may not be your best bet.

You should instead look at your personal financial goals and appetite for risk (imagine that!). With those things in mind, you can then use some of the following rules to guide you in setting up and maintaining an allocation that works for you.

3. Use “bucketing” to stretch out your assets

Different assets grow at different rates, and smart allocation is critical to ensuring that those differences are timed out in your favor. A trick called bucketing can help you get the most bang for your buck here, especially once you are actually in retirement.

By having high-growth assets “trickle down” into ones that do not grow as much, you can keep up your income while also maximizing growth. More specifically, it looks like this:

  1. Draw income from your cash “bucket” in small, consistent amounts;
  2. Refill your cash bucket by selling off bonds in small, consistent amounts;
  3. Refill the bonds bucket by selling off stocks when conditions permit.

4. Use “decision rules” to give your plan flexibility

You want your portfolio to be able to meet your income needs and grow at the same time – regardless of what the market is doing. You cannot predict the market, of course, but rules like these can help you make the best of whatever it throws at you:

  • Replenish your cash and bond supply by selling stocks when their value is up
  • Replenish your equity supply by buying stocks when their value is down
  • Keep enough cash on hand for two years of income, then use anything in excess of that to rebalance stocks and bonds as needed.

5. Do not try to time the market!

Seriously, don’t. This is one of the most important commandments on my list, but also one of the simplest. So I will just leave it at this: unless you have bona fide psychic abilities, waiting to sell until prices have peaked or waiting to buy until they have bottomed out is a fool’s errand. And you do not have bona fide psychic abilities.

6. Do not buy or sell stocks based on price

I know this sounds counterintuitive, but consider: when everyone is busy trying to predict the behavior of stock prices, they often ignore those stocks’ underlying value: corporate earnings. And a company’s share price is by no means in lockstep with its earnings, as the below chart demonstrates.

There is often a big difference between a company's stock price and its actual earnings

The data here is admittedly a bit outdated, but the lesson still holds: share price is not a reliable indicator of a stock’s underlying value. Therefore, buying cheap shares simply because they are cheap, and selling expensive ones simply because they are expensive, is little better than gambling.

Instead, you should buy stocks when they are undervalued and sell when they are overvalued. But how do you know which is which? I am glad you asked…

7. Do not trade stocks – invest in companies

As the famous (and hugely successful) investor Peter Lynch put it, “I’d love to get next year’s Wall Street Journal; that’d be very helpful. But I don’t know what’s going to happen in the future; I want to find right now.” And I very much agree. Do not buy or sell a company’s stock for what its price may do in the future; instead, base that decision on what the company itself is actually doing in now.

Remember how 2022 was so rough for the stock market, at least compared to 2021? Funny thing about that – in the first quarter of that year, 62% of companies in the S&P saw a drop in stock price, but only 40% actually saw a decline in their profits.

Hmmm… sounds like a value opportunity to me! But if you are only looking at the share price, and trying to predict the (often irrational and unpredictable) ways it may move in the future, you will miss such opportunities. Far better to focus on those quarterly earnings reports, dry though they may be.

8. Do not bail out!

People often pull their money out of the market en masse when things get scary, thinking that is at least the safer option even if it is less profitable. Some even go so far as to “sell in May and go away” every year, in an attempt to avoid (supposedly) regular market slumps. After all, “you can’t lose if you don’t play,” right?

Wrong! Inflation is the silent killer hunting all of us, and it is far more likely to catch those who are not investing. This is not news to anyone, yet it is surprisingly easy to forget. Even if you only pull out for short periods and get back in when things “look better,” that is likely to hurt you in the long term. For example:

A "sell in May" strategy can hurt portfolio growth in the long term

All that being said…

9. Do not be afraid of “lazy money”

Putting your money to work in investments is important – but your cash savings are just as important. Even if that cash does not grow much itself, it is the lifeblood of your overall plan. It provides your retirement income, cushions you against emergencies, and greases the wheels of your portfolio.

By the way, do not assume that your cash is doomed to not grow at all. That is by no means true, especially in 2023. If you look beyond the old fallback of a savings account at a brick-and-mortar bank, there are a variety of options for keeping your money safe and accessible while also getting some modest growth:

Low-risk securities like CDs and money markets have seen exceptionally good returns in 2023

Even if you do not use options like these, however, your cash is still essential. Granted, it is a “negative yielding investment” when you factor in inflation. But that negative return is simply the price we must pay for the safety and liquidity that comes with holding cash. 

10. Remember that every slump is an opportunity.

For the average 60/40 retirement portfolio, 2022 turned out to be the third-worst ever, only bested (or… worsted?) by a couple of years during the Great Depression. But paradoxically, low points like this are a doorway to future success, for at least three reasons:

  1. Slumping stock prices offer an easy entry point into the market. If you have the resources to spare, now may be the time to find and buy some undervalued assets that will gain value once things turn around (but remember Commandment #6 – “undervalued” does not just mean “cheap”).
  2. Low bond prices make for high bond yieldsWe covered this counterintuitive but crucial benefit of bonds (along with others) on our blog awhile back, so in brief: now may be the time to take advantage of discounts in the bond market as well.
  3. Holding your course is likely to pay off. In his analysis of the worst stock market years in history, Ben Carlson notes that in every single case, the market rebounded to achieve positive returns – often major ones – within five years. A very good reason to hold your course even when things look scary. Or, even better, “buy the dip.”

Remember, “that which does not kill you makes you stronger.” Or at least it can, if you come out the other side with a willingness to learn and a proactive rather than reactive attitude. It is just as true in money as in life, and just as important to remember now as it has ever been.