Last Update: July 2021

A common fear plaguing the masses these days is how to invest with a market at all-time highs. Such sentiment has been expressed by a number of all-star pupils recently in my option classes. The lack of time in such a setting and requirement to cover other subject matter handicaps my ability to respond in a comprehensive fashion.

Which is why I love this blog. It affords me the opportunity to tackle a topic in as comprehensive a fashion as I want. And nothing is more deserving than the common query of getting started when the market is ostensibly in the nosebleeds.

Let’s put aside the argument for whether the market is indeed unjustifiably high and simply focus on some suggestions for how to conduct yourself in such an environment.

First, realize the markets are virtually always close to all-time highs. It’s the norm, not the exception. I’ve already written about this (see here), but let me just summarize by saying it’s silly to wig-out and be unwilling to invest with markets near record highs. There’s always some hobgoblin haunting investors. If you’re waiting for the coast to be clear before putting a dime in stocks, bonds, commodities, or some other asset class, then, well, you’ll never invest.

These first few ideas are geared toward passive investors looking to accumulate assets over time.

Idea #1: Create a diversified portfolio of stocks, bonds, commodities, and real estate that fits your tolerance.

Create a diversified portfolio of stocks, bonds, commodities, and real estate that fits your tolerance. If putting 100% of your money in stocks will cause you to panic and sell next time the market drops 30%, then the answer is simple – DON’T. Put 50% or 30% or whatever amount you’re willing to have experienced the roller coaster ride that is the stock market. For example, if I have a $100K account and put $50K in stocks, then I know during a particularly vicious bear market I could see that $50K drop to, say, $30K. Though it’s a 40% drawdown in my stock holdings, it’s only a 20% drop in the total account value.

If you panicked and sold your stock holdings during the dot-com crash or the sub-prime meltdown it probably means one of two things. 1) You had too much exposure to stocks thereby ensuring your panic-prone digits would reach for the sell button at the exact wrong time or 2) You failed to realize (or were simply never taught) about the long-established history of stock prices experiencing significant downturns once or twice a decade.

As an aside, just because the U.S. stock market is at an all-time high (and the bond market for that matter) doesn’t mean that everything is. Commodities aren’t (GLD, SLV, etc…), nor are emerging markets (EEM) or foreign developed markets (EFA).

Idea #2: Buy portfolio protection.

Buy portfolio protection. If you’re willing to give up the first 3% to 5% of upside over the next year or so, you can limit your downside exposure to around 10% to 15%. In other words, if I invest $100K  in a stock portfolio and was willing to pay $3K to $5K for protection I could probably limit my risk to $10K or $15K instead of the whole $100K.

Consider this a plug for learning the protective put strategy and how it can be used to build a moat around your portfolio.

Idea #3: Sell out-of-the-money puts.

If you’re not a willing buyer of stocks up here but are interested in dipping your toes into the water if we get a 5% to 10% pullback, then sell out-of-the-money puts. It allows you to get paid for your willingness. For example, with the SPY at $217 you could sell the October 195 puts for 75 cents. Imagine you received $75 every month simply for being willing to buy 100 shares of the SPY at a 10% discount. If it never drops 10%, you get to pocket around $900 for the year. If it does drop 10%, then, hurray! You’ll be able to buy shares 10% off the highs.

Tune in next time for some thoughts for active traders.

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