It’s been a volatile year so far.
But when you consider we’ve seen three straight years of incredible gains in the world’s largest stock market index, the S&P 500, well, a pullback shouldn’t be unexpected.
In fact, I would argue a correction should have been anticipated.
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According to Calamos Investments, the chart below “shows the maximum intra-year equity market drawdowns since 1980. From this, we can see how frequently at least one double-digit decline occurs within any given calendar year. In 21 of the last 41 calendar years—more than half of the time—the S&P 500 saw a double-digit pullback within the year.
Basically, drawdowns are a part of investing. They should be expected and the best time to prepare for them is before they occur, not afterwards.
Why?
Because options premium is significantly cheaper, which means portfolio protection, using a variety of different options strategies, is far more affordable.
Unfortunately, most investors don’t view hedging strategies, if done correctly, as a way to manage all of the risk in their portfolios. Investors focus more on the cost of the insurance and how much it takes away from their potential return.
But what we all need to understand is that unrealized profits aren’t really profits until they are, well, realized. Until then your portfolio balance exists as a risk to be managed, and not an earned reward. Again, as seen in the chart above, markets don’t move continually higher. Pullbacks occur. Manage accordingly.
I mean, come on, we buy insurance on our homes, cars, life and a host of other uncertainties, yet very few of us “buy” insurance on their hard-earned investments. It makes no sense.
As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.