[Today’s post on anchor strategies features a multitude of links to other articles and videos, both on MHFG and to other websites. If you haven’t yet, now is a great time to read my disclosure statement here.]
Prologue
Somewhere on the open sea…
Sailor: Ahoy captain, storm on the horizon!
Captain: Waves be coming. We best ride this one out near shoreline, mates! Set sail for the nearest island, then drop anchor!
I did not start this blog to be a novelist, but that was rather fun. Today, I will tell you why pirates and investors are similar and how they can utilize anchors to their benefit.
Now pirates, just like modern-day investors, chase after treasure. However, volatility can wreak havoc for both when unprepared. If either is unready for waves, both at sea and in the markets, seasickness, waterlogging, and even sinking of one’s ship can happen.
So, how is an investor to reap treasures without selling their portfolio during a stormy market? The answer for some is buried deep below in anchor strategies, which is the focus of today’s post.
Hence, anchor your attention and prepare for boarding because we will now discuss anchor strategies!
Act 1 – For Who & Why
Anchor strategies, just like pirates, are as old as the sea and are a method to navigating risk while still capitalizing on market gains.
With anchor strategies, the premise is simple: You anchor part of your portfolio to a safer asset while you invest the remainder in riskier assets. The anchored portion acts as a buoy, preventing your portfolio from being lost amongst the waves during market squalls.
However, most investors should tend to the masts and deploy their sails, steering clear of anchor strategies if possible.
Why? Because as stated by Peter Lynch and freshly rediscovered by A Wealth of Common Sense’s Ben Carlson, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
The moral Lynch alludes to is that one should invest appropriately for their risk tolerance, as discussed here. Once you have done this, sit back and let the markets do the rest, only rebalancing as needed.
Nevertheless, sitting back is easier said than done.
During the Corona Crash, I learned firsthand as an advisor that investing is not black and white. Instead, it is an emotional undertaking that must appreciate and appropriately plan for the human condition. If this is not done, many will fail to stay afloat and instead sell when the markets collapse.
Thus, anchor strategies can provide treasure without venturing too far out of the cove for those heavily concerned with market risk and losing money through an anchor.
Act 2 – How anchoring works
Anchoring is the act of investing part of one’s portfolio in safe assets that are unlikely to ever lose value due to market influences. Examples include Certificates of Deposit (CD), money market funds (MMF), cash, and fixed annuities. For pirates, safe assets are fruit and rum; otherwise, scurvy will surface, and you will be asking, why is the rum gone?
Anchor strategies are a meaningful way to hedge against risk while still participating in the market. They do this by guaranteeing that funds will still be there even if the market goes belly up. Then, with the remaining investments, riskier investments are selected for growth potential.
Such investments include stocks and bonds, funds, or other assets that can offer meaningful growth. Importantly, anchor strategies offer a negligible safeguard against periods of high inflation. While you may not lose money due to volatility, you will see eroded purchasing power as everything around you rises in price. So, be wise with how much you anchor!
Act 3 – How much to anchor
How much to anchor depends entirely on you, but a good starting place is an amount you cannot stomach losing. Say you retire and have $500,000. You do soul search and number crunching, realizing that dropping below $300,000 would be catastrophic for your lifestyle.
So, in this situation, one option is to anchor $300,000 in CDs while investing the remaining $200,000 in an indexed target-date fund that matches your retirement year.
By anchoring part of your portfolio, you prevent total loss even in the worst economic downturns. Notably, anchor strategies won’t help if your country experiences an economic and societal collapse. However, you will have more significant concerns than your retirement savings if that happens.
Epilogue
Volatility can be scary, but the markets are one of the greatest wealth creators in history, and everyone should consider some exposure. I encourage you to invest appropriately for your risk level, meaning you can stomach both the ups and downs. Remember, no two investors are alike, and some can handle large risk undertakings for treasure, while others cannot. We are all pirates in search of gold, and how you find it is up to you!
If you cannot tolerate losing money, consider dropping anchor further from the port to enjoy the ocean while still affording yourself the protection that the cove can offer.
It has been a pleasure sharing knowledge with you at the harbor, but alas, the journey at sea must begin. Do you think anchoring your portfolio makes sense, or is it a fruitless endeavor for your situation? Please let me know in the comments below and as always, have a great day!
Mile High Finance Guy
finance demystified, one mountain at a time
I’m curious if there’s any way to hedge against anchoring strategies? For example, something that makes money if the market is too stabile and not volatile enough?
Maybe it’d be a good idea to put most of your money in CDs and other save things when the market seems like it can go crazy (like during wartimes). But it may also be a good idea during those items to somehow buy some asset that makes money when the market is very stable and loses money when the market crashes deeply. This way:
– Your anchor investments will do very well relative to the market if it crashes.
– Your anchor investments won’t do that well when the market is somewhat indifferent, but your hedge will make some money.
Angie,
Anchor strategies could be hedged against by using Options or derivatives. However, adding either to your portfolio will introduce even more risk, which anchor strategies try to mitigate. So while possible, it wouldn’t make sense for the target audience to hedge.
Olaf, the Mile High Finance Guy