Three Critical Strategies for Your Portfolio Today

Doc’s note: Porter and I don’t always agree… But one thing we do agree on this year is that the current bull market is running out of steam.

We can’t know for certain when it will end. And that’s why I’m sharing a Stansberry Digest issue where Porter details three things you should always do as an investor… no matter where you think this market is going.

And if you want to hear what Porter – and other Stansberry insiders, including me – think about the current market, tune in tomorrow night at 8 p.m. Eastern time. We’ll tell you if you should be buying stocks, the biggest mistake you’re making right now, how to hedge your portfolio, and much more.

Click here to reserve your spot.

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Your success as an investor can be predicted in a few simple ways…

But I don’t believe any indicator is more important than your ability to be cautious when others are greedy and to be greedy when others are afraid.

And I’ve been telling readers all year that great bear markets don’t start when people are worried and the markets are quiet. They began in periods of incredible excitement and financial euphoria. They begin with markets at all-time highs, when speculation is rampant.

Yes, stocks may still run higher. But this market is running on fumes. We will see it all fall apart this year.

You can’t know if I will be right and a bear market will develop soon. And even if I’m 100% right, you could still easily make your biggest gains of this cycle in the final few months of the bull market.

In other words, even if there is a bear market and even if the markets as a whole end up down for the year, you could still make a lot of money by simply following your trailing stop losses and hanging on as long as you can.

That’s why I think it’s important that you simply follow sound investing principles, rather than try to time the market. So here are the three things you should do this year (and every year).

1. Make sure you truly understand how much risk you’re taking.

I’m frequently astounded (and terrified) when I talk to individual investors, and they describe their strategies. A portly gentleman wearing overalls told me proudly at a Casey Research meeting in Boca Raton, Florida, about six years ago, that he’d mortgaged his house to buy junior mining stocks. He wasn’t worried about the pullback (which became a grinding, four-year bear market and probably wiped him out) because he was diversified across more than 30 different tiny companies.

My bet? If you’re managing your own portfolio, you’re probably taking at least twice as much risk as the S&P 500 Index. That is, if there’s a bear market and stocks fall 20%, your portfolio will most likely fall more than 40%.

If you don’t know how much risk you’re taking, you’re much less likely to guard against those losses. But if you do know how much risk you’re taking and which positions are the riskiest of all, you can do a much, much better job of running your portfolio safely.

You can “spitball” this risk assessment by simply measuring the weighted average of the “beta” of your individual positions. A beta of “1” means that a stock has the same volatility as the market as a whole. A beta of “0.5” means a stock is half as volatile as the market. And a beta of “2” means it’s twice as volatile as the market.

You can generally find the beta on any security by using widely available databases, like Yahoo Finance. Careful, though… sometimes the data are glitchy. So if you see a number that doesn’t make sense, check it using another source.

Once you understand how much risk you’re taking, my suggestion is you rebalance your portfolio so that you take less risk than the S&P 500. Remember… you want to be cautious when others are greedy.

You can lower your risk by selling down risky positions and building cash in your portfolio. You can also lower your risk by adding hedges that have a negative correlation to the stock market, like short selling positions.

2. Out of all the studies I’ve read about portfolio risk-management strategies, nothing is more powerful than risk-based position sizing.

In other words, whether you follow hard stops or trailing stops, the biggest improvement to portfolio performance comes from using a position-sizing strategy that equalizes the capital at risk in each position.

This year, give yourself the best chance at success. Rebalance your portfolio so that you’re risking the same amount of capital in each position.

You can approximate this approach by using each stock’s beta to adjust your position size. If a stock has a beta that’s less than one, then increase your position size until multiplying its beta by that factor will equal one. And do the inverse for stocks with betas that are greater than one. Doing so will give you a risk profile that’s equal to the markets. If you want less risk, then standardize to a beta of 0.99 or less, depending on how much risk you want to take.

The important thing is to make sure that you’re taking the same amount of risk in each position. Nothing else you can do this year is more likely to increase your portfolio’s return.

3. Build your portfolio around our highest conviction, most capital-efficient recommendations.

While these “safe and boring” recommendations may not excite you or make you a killing in the short term, they are the best way to build real wealth in the stock market. Over time, nothing beats this approach.

The very worst time to buy stocks in my lifetime was November 2007.

That was the month when stocks hit their last high before the crisis of 2008. That was just before the S&P 500 went on to decline by almost 50% over about 18 months. It was during that month – virtually the worst time in history to buy stocks – that I was researching a company that I knew would become the best recommendation I would ever make in my career.

And I said so at the time.

On December 7, 2007, I sent the following to the subscribers of my newsletter, under the headline “Our Best ‘No Risk’ Opportunity Ever”…

I have come to believe evaluating capital efficiency gives us a permanent edge in the market, as almost everyone else ignores this crucial variable… Few people even understand the concept.

And as my British friend Tom Dyson would say, “I am quite pleased” to tell you that we have an opportunity right now to buy one of the greatest consumer franchises of all time at a no-risk price. As you will see, this business is the utter picture of capital efficiency. Or in terms [Warren] Buffett would recognize, this company has among the highest returns on net tangible assets in the world, uses very little leverage, and has a balance sheet where economic goodwill dwarfs all of its other assets.

Best of all, this company has a unique corporate structure and the backing of a major state’s government. In this situation, the management is literally required by a state’s attorney general to do what is in the best interest of shareholders – or go to jail.

The longer you hold this stock, the more rapidly your wealth will compound, and you’ll never have to sell – ever.

Longtime subscribers might remember that famous issue of my newsletter. I’ve referenced it many times over the years… But today is an important milestone.

It has now been more than 10 years since I made that recommendation – which was to invest in chocolate maker Hershey (HSY). The company is one of the best examples in the world of a dominant, capital-efficient, noncyclical, consumer-franchise business. It rarely trades at an attractive price, but at the time, Wall Street was convinced Hershey wouldn’t be able to compete effectively in the global markets against Cadbury, and so all was lost. We took advantage of this temporary dip in sentiment to establish a world-class, long-term investment. I begged my subscribers to put a meaningful amount of wealth in the company.

Of course, it’s easy to promise that long-term capital appreciation is certain. It’s much harder to deliver. In this case, I forecast the total return would be around 15% annually for 10 years. I was wrong. The total return (assuming you reinvested your dividends at the time they were issued) was “only” 13.7% per year, or about 206% over the 10-year period. My apologies…

If you took my advice, you can console yourself with this: Compared with Hershey, the S&P 500 has grown 8.5% a year over the same period – and been about twice as volatile as Hershey.

Assuming you put $100,000 into the shares when I first recommended them, you’d own 3,173 shares. The total value of your shares would now be just a few dollars more than $360,000. And here’s the best part: Hershey would have paid you more than $80,000 in dividends during the past 10 years.

If you wanted to begin spending these dividends, you’d be earning 8.4% a year on your original capital, a rate of return that’s likely to increase each year going forward.

But if you have these shares, I’d recommend simply continuing to reinvest the dividends because the compounding returns are just getting started. I promised when you bought this stock back in 2007 that you had a good chance of earning 20 times your money over 20 years. That assumed a 15% total annual return for 20 years.

Although we have been trailing that prediction – slightly – Hershey continues to grow its business and its dividend, and it has retained its economic goodwill and thus its capital efficiency. There’s no reason to change a thing. Just set it aside, and we’ll check on it in another 10 years.

As I told you back then, “This stock could easily become the best investment you make in your entire life.”

As I said, we recommended Hershey at virtually the worst possible time. But when you buy a great, long-term investment, it shouldn’t matter much whether you buy stock today or next week or next month.

And that’s good: Great long-term investments always offer you plenty of opportunity to buy more shares. Don’t doubt your analysis as long as the company continues to deliver on its model. Just buy more… and wait.

So remember: When you make a long-term investment in a high-quality business, don’t let the macro factors scare you out of your position. As long as the company continues to execute according to its model, stick with the position.

That’s the best, safest, and surest way to get rich in stocks.

Let 2018 be the year you begin to make only high-quality, capital-efficient, long-term investments.

In about 10 years, you’ll think it’s the best decision you’ve ever made.

But if you want to take your investing another step further, tune in tomorrow night at 8 p.m. Eastern time.

I’ll share my personal gold strategy… which newsletters you should be following right now… and my No. 1 investing strategy in today’s market. Plus, as an added bonus, you’ll have a chance to win one of two $5,000 prizes, simply for showing up.

Reserve your seat here.

Regards,

Porter Stansberry