Are You an Amateur or a Pro?

A volcanic rumble... How did your portfolio perform on Wednesday?... Are you an amateur or a pro?... Why we don't invest for the end of the world... In the mailbag: 'completely worthless'...

Did you panic? Were you afraid?

Stocks got beat up on Wednesday. After starting the week at new highs (around 2,400 on the S&P 500 Index), stocks fell about 2% by midweek, with most of the volatility on Wednesday.

Anytime investors are reminded that stocks can go down as well as up in value, our mailbag "lights up." Subscribers suddenly want to have constant contact with us. They need reassurance. They suddenly can't remember how to use TradeStops because the green, yellow, and red code isn't as clear as buy, hold, and sell. (Yes, those are real comments, you'll see them below.)

Friends... If this week's market action bothered you in any way, there's a huge problem with your portfolio.

Think honestly. When you first saw how the market was going to open (way down) on Wednesday, what was your first reaction? Or, if you didn't see the open, what happened on Wednesday night when you first saw the news? Or during the day when stocks just kept going down, lower and lower?

Be honest with yourself. If there was even a twinge of fear, you've got a big problem. Let me explain why...

Wednesday saw about three weeks' worth of market gains wiped out, temporarily. It was a tiny, 2% move lower. It wasn't a bump in the road. It was barely a ripple on the calmest lake the equity markets have ever seen.

Since 2015, stocks have been ripping higher, propelled by "rocket fuel" – central banks, sovereign wealth funds, corporate buybacks, and value-ignoring index-fund investors. There's hardly been a down day in nearly two years. This incredible rally has created record levels of investor complacency – aka, investor stupidity.

It has also, almost surely, lulled many of our subscribers into portfolio allocation decisions that are far too aggressive.

On the golf course, virtually every amateur player overestimates how far he can hit the golf ball, usually by 20% or more.

Why? Because our best-ever shot becomes our expected outcome.

As we're sitting there on the tee box, we're thinking "I crushed the ball the last time I played this hole. I'm sure I can do it again." Instead of making a conservative swing on the ball – a swing we can hit well nine out of 10 times – we end up taking the big cut... the move that almost never works.

Pro golfers don't make this mistake. They study the distance of every club in the bag, based on their most repeatable swing. They know their distances down to the precise yard. And they don't try to make swings they can't repeat virtually every single time.

Amateur investors make the same kind of mistake as amateur golfers.

They vastly overestimate the expected outcome of their investments. Think about this the next time you buy a stock. Write down what you're expecting to make (annualized) from the investment. Now go and look at what your actual annualized returns have been from similar investments.

The odds are you're overestimating your expected returns by at least 100% – meaning, you're expecting to make twice as much as history suggests you will.

You're probably doing the same thing right now in your portfolio: you're holding positions because you're sure they're going to soar.

Meanwhile, it's unlikely stocks will produce the sort of returns you're expecting...

With stocks trading at near record valuations, with GDP growth below 3%, with consumer debt crashing, with extremely low interest rates, and with weak and declining commodity prices, it's unlikely stocks will produce double-digit annualized returns in the timeframe you're planning for. Very unlikely. Virtually impossible.

But every time you buy a stock, I'm sure you expect to make more than 20% over the next year. Or maybe even in the next quarter.

That's because, like an amateur golfer, you're thinking of that great "shot" you hit back in 2015 – that stock you bought two years ago that's soared with the market.

But that's not what's going to happen this time.

Wednesday was a warning from the stock market "volcano."

It was just a minor rumble. A tiny taste of what will happen when there's another bear market, a decline that's 10 times worse. (A bear market is a decline of more than 20% on the major indexes.)

If you were worried on Wednesday, you'll be crushed – wiped out – by a bear market.

I know... you say you will follow your trailing stops. Or, you say you will just hold on "no matter what." But almost everyone who sets out to be a "buy-and-hold" investor ends up becoming a "buy-and-fold" investor. Just as you overestimate your expected returns, you're also overestimating your risk tolerance.

If you'd asked investors back in 2009 about their risk tolerance, they all would have said "none." They would have told you "I'm tired of stocks. I only want safe investments. Just give me something that's safe... "

Today, you hear exactly the opposite. At conferences, I'm constantly seeing subscribers telling people "I'm an accredited investor. I can handle the risks."

But they can't. Not really. Almost no one can.

Here's the best way to think about the risks you're taking...

If you're 100% invested (long stocks) it's only a matter of time before you suffer a 50% drawdown – at a minimum. Warren Buffett, the world's best long-only investor has seen the value of his equity holdings drop by 50% three times in his career. And it has happened twice since 1999.

You probably aren't as good of an investor as Warren Buffett. It's likely that your results won't be as good as his have been... which means that if you are a long-only investor you will (not might) suffer more than a 50% decline in the value of your equity portfolio.

If you're using trailing stops, you can greatly limit this volatility.

And that's why I endorse TradeStops so strongly. (To be fair, I'm also a part owner of the company. But I invested in it because I share in Richard Smith's mission... To give individual investors the best possible tools to help them become more successful investors.)

In fact, if you merely use a trailing stop loss and reasonable position sizes, I can almost guarantee that your investment results will become dramatically better.

Next Wednesday night, I'm hosting a free live event called "The Day the Bull Market Will End" that will explain how to use trailing stops to protect your portfolio and greatly improve your long-term results. The best part, you can do it without buying a single new stock. Reserve your spot by clicking here.

And there's another, even better way to limit the volatility of your portfolio.

Consider "hedging" your portfolio by adding small positions in investments that are designed to go up when the stock market goes down – like short sells and gold stocks. You should also consider a big allocation to short-term corporate bonds and mortgages. Or if you don't understand these kinds of investments, then simply hold cash.

In our Portfolio Solutions newsletters, The Total Portfolio is a diversified and hedged portfolio.

We have about 25% of the portfolio in corporate bonds. Some of this allocation (10%) is directly in carefully selected high-yield bonds. But the majority of this allocation to fixed income is via high-quality insurance stocks, which are really just big piles of bonds (plus underwriting profits).

This is the firm foundation of our portfolio. And to further reduce volatility, we have another 20% of the portfolio long super-safe mortgages and cash-like, very-short-term loans to investment-grade corporations.

Thus, about 45% of our portfolio is in fixed income and cash. It's like driving with a parachute tied to our car. It's going to limit our top speed... But there's no way we will crash in the corners. That doesn't mean we can't still produce very good results, though. We've been tracking on about a 15% annualized rate of return.

But the real magic in what we're doing are the two things that you probably won't do. Ever.

We have 10% of the portfolio allocated to short-sell positions and gold stocks. This doesn't reduce volatility, as these positions are enormously volatile. But they're also negatively correlated. So, when stocks go down (like they did on Wednesday), this part of the portfolio goes straight up.

On Wednesday, the S&P 500 dropped 1.8%. Our Total Portfolio was down, too. But only by 1.3%.

That probably doesn't seem like a big difference to you. But proportionally, it's a huge difference. Our portfolio's decline was more than a quarter less than the S&P 500. What if that move down had been 10 times worse, like a market correction or even a real bear market?...

I'm certain you'd feel a lot better looking at a 13% portfolio decline than an 18% portfolio decline. And if you can get this reduction in risk without a corresponding decline in performance, why wouldn't you hedge your portfolio?

Again, if you look carefully at our Total Portfolio, you'll find a very conservative allocation mix, with almost 50% of the portfolio in very stable investments like mortgages, corporate bonds, or short-term credit facilities, with an additional 10% of the portfolio completely hedged (short positions, gold stocks). This allocation allowed us to reduce our downside by almost 30% on the market's worst day of the year so far.

If you were nervous on Wednesday... change your allocation immediately. Act like a pro. Go for the "shot" you know you can hit. Stick with an allocation that lets you sleep at night and that fills you with confidence on bad days in the market.

And now... the mailbag...

It's a fascinating reflection on human nature. When the stock market falls (even when it falls less than 2%), the resulting submissions to the mailbag get a whole lot more interesting. Make yourself a cocktail. Get comfortable. And get ready for a belly laugh.

And, please... don't forget to send us your tale of woe. After all, it's surely all our fault: feedback@stansberryresearch.com.

New 52-week highs (as of 5/18/17): Paysafe (PAYS.L), Tencent Holdings (TCEHY), short position in Avis Budget (CAR), and short position in Hertz Global (HTZ).

"Car Rental Companies: Nice article but completely useless without a final recommendation about what to do now. I can read articles for free anywhere. I'm paying you for a recommendation service." – Paid-up subscriber Thomas M.

Porter comment: Actually, Thomas... you're not paying me for anything. The Digest is free.

And while you continue to receive Sjuggerud's and Eifrig's subscription research, I noticed that you allowed your subscription to my newsletter (the modestly titled Stansberry's Investment Advisory) to lapse last November. That's why you haven't received any of my full recommendations lately. But you did receive our detailed recommendation to short Hertz and Avis. We sent it to you last October. It was the last issue of your subscription.

Horse, meet water.

Sure, I'm picking on Thomas a little bit... But there's a deeper point here that's important. The part of our work that's "actionable" – the specific recommendations to buy "XYZ" or to sell "PDQ" – isn't the valuable part. The investment advice should be obvious if we've done our work well. It's all the work that comes before the specific advice that matters.

After all, if you don't understand why a business is likely to succeed or fail, there's no way you'll stay in a position for long enough to succeed. Fear and uncertainty will beat you every time.

And as I hope our long-time subscribers would agree, there isn't another research firm anywhere that backs up their recommendations with a more thorough understanding of the fundamentals and the context of the investment situation.

If you know why the entire car-rental business is going to collapse – unsustainable debt load and a broken business model – then figuring what to do is the easy part. Well, at least for most people. Folks like Thomas end up dying in a fire because nobody told them which exit to use.

And by the way, we do tell you "what door to use." But I sure hope that's not the part of our work that you depend on most.

"As a subscriber to Portfolio Solutions, Capital Portfolio, I would like to see a little more communication pertaining to portfolio recommendations other than monthly updates. I get daily e-mails from TradeStops, but they are really unintelligible. Red, Green, and Yellow are somewhat confusing as what action I should be taking. A simple "sell, hold, or buy" would be much better... Particularly during weeks of volatility, I would like to see Porter issuing more advice or assurance." – Paid-up subscriber Paul H.

"Since we get portfolio updates only once a month (Portfolio Solutions, Capital Portfolio), can I get your feedback on the following:

1. I am a TradeStops subscriber. When any stock in the portfolio hits its trailing stop, can I assume we should sell the next day without waiting for the next update?

2. If yes to selling the next day, am I correct in assuming those sale proceeds should sit in cash until the next update that should provide further instructions on what to replace sold stocks with, and how much to buy of new recommendations? I want to be prepared when the waves come in!

Thanks." – Paid-up subscriber Tom D.

Porter comment: Paul, Tom... I've put your questions together because I thought they were similar.

You should both call our customer-service folks and make sure you understand the service you've purchased. We provide constant, real-time updates to Portfolio Solutions subscribers (all levels) via the Stansberry Newswire, including daily summary e-mails with all the moves in the portfolios.

Judging by your comments, I don't think you're aware this higher level of service is already available. Also, if you'll look at The Capital Portfolio online (or in the e-mail we send) you'll notice that updated stop-loss points are included for every position.

We don't automatically use the same stop-loss points as TradeStops, which offers a variety of different risk-management levels and tools. So just because TradeStops says you've hit a stop loss doesn't mean that we have in The Capital Portfolio. Of course, you're free to use TradeStops to track The Capital Portfolio (and we hope you will). But you'll have to enter our recommended stops (which is easy to do).

And finally, Paul... I had to chuckle at your Red, Yellow, and Green criticism. Hard to understand, eh? Do you drive?

Seriously, Paul, if a 2% move lower in stocks made you so uncertain that you were immediately seeking reassurance from me, don't you think you have too much exposure to the stock market?

"Why does it matter how high stocks get if the system collapses and you cannot get your money out of your brokerage account? You need to address the possibility of a complete collapse as some are saying. I know that the standard response is to have precious metals in your control, but that is not so easy; what to do?" – Paid-up subscriber Terry D.

Porter comment: I can't think of another investment adviser anywhere that has published as much work as we have on exactly how to prepare for a full-blown currency crisis or global financial collapse. I've written whole books about it (The End of America and America 2020). I'm sure you've seen these... We've spent something like $100 million advertising these ideas.

Feel free to check them out.

I believe that the global financial system will collapse. I believe it must collapse because the system we have today is completely immoral and thus, unsustainable. The imbalances caused by paper money have grown exponentially bigger over the past decade. And the "wobble" in the system is becoming more and more severe. Someday soon, it's going to tip over. And when confidence is lost, there's nothing behind our current system to stop the panic. Our entire global economy runs on nothing more than the "faith" and "credit" of the United States government. Meanwhile, there's nothing faithful about our leaders, and they've been paying their bills with a printing press for decades.

Show me any time in history when a country with the world's largest military and the world's biggest debts begins printing money to pay its bills... and I'll show you a bloody revolution.

Of course, saying these things and writing these things makes me seem like a radical... or a nutjob. But after the crisis... historians will wonder how the bubble went on for so long and why nobody saw it coming.

What no one can know, however, is when the system will collapse. It could happen next week. Or it could happen in 25 years. Nobody knows.

So I don't think it makes sense to pretend like a crisis is the only possible investment outcome of your life. That's why in The Total Portfolio that I publish, we're still holding about a 30% allocation in our "core" equity positions – investments like Facebook and NVR. These investments have beat the market handily over the past few months. And that's why only about 10% of the portfolio is short the market... And even less is long gold stocks.

It doesn't make sense to invest like the end of the world is coming tomorrow because there's a 99.99% chance it isn't.

But just because a financial collapse probably won't happen tomorrow doesn't mean it won't happen eventually.

That's why, in addition to investing for the long term in stocks, real estate, and timber, I've also worked hard to prepare my family to survive a financial crisis.

What have I done?

First, I own plenty of gold bullion. More than enough to sustain my family for years. I like to buy a little more every year. It's a great way to save money. And it sure helps me sleep at night.

(By the way, I've never understood what's hard about owning bullion. It's far easier to hide $1 million in bullion than it is to hide $1 million in cash.)

Second, I own a farm. In a real crisis, having a farm is just about the best asset you can have.

Third, I own a "bolt hole" – a house, high up on a mountain in rural Pennsylvania. It's surrounded on all sides for miles and miles by well-armed rednecks and tough Amish farmers who don't take kindly to strangers or thieves. In a crisis, the character of your neighbors matters more than just about anything else.

Fourth, I own real estate outside the U.S. and could easily arrange for a residency permit if I wanted to move. (I don't think I'll ever have to leave America, but if a civil war breaks out... or a communist revolution... I'll probably leave.)

Sure, I've got plenty of guns and ammo. But you can't shoot everyone. I've seen a real riot in Baltimore. It happened about 10 blocks from our offices. Trust me, if that crowd had wanted to burn down my office building (instead of looting drugstores) no amount of .223 ammo and one rifle would have made much of a difference for very long. If there's a real crisis, it's far better to have an escape plan than a battle plan.

"Sign of a top... Steve Sjuggerud's recommendations are working out." – Paid-up subscriber Allen W.

Porter comment: That's just mean.

Regards,

Porter Stansberry
Baltimore, Maryland
May 19, 2017