How Prepared is Your Portfolio for a Stock Market Catastrophe?

Tony Sagami |

My parents were hard-working vegetable farmers in western Washington, but making ends meet was always a struggle.

My classmates laughed at my hand-me-down clothes and logger boots with holes in the soles, but I never went to bed hungry and my mother kissed me goodnight every night until I left for college.

Farm work was hard and I hated it—I mean really hated it—at the time, but I now think that those years on the farm were the foundation of the success that I enjoy today.

Moreover, there’s a surprising number of investment lessons that I learned as the son of a farmer.

Boring Work Is the Most Important Work

Farming is far from glamorous, but some of the work was dreadfully boring.

In the spring, my father would have me pick rocks out of the fringes of the farm, and in the summer, I spent thousands of hours on my hands and knees pulling up weeds. It was boring and seemed meaningless at the time, but every successful business needs a strong foundation, and the basic building block of preparing the soil is crucial.

The same is true of investing. Reading annual reports, financial statements, and balance sheets can be boring, but it is that fundamental, time-consuming research that sets you up for long-term success.

Summer Profits Come from Winter Efforts

My non-farmer friends assumed farmers took it easy during the winter. Wrong! Even when snow covered the ground, my father still worked a minimum of 12 hours a day. There may not have been any crops to harvest in winter, but there was always plenty of off-season work to do on the farm, such as repairing the farm machinery and mending fences.

My high school basketball coach used to scream at us that December games are actually won during the off-season workouts, and the same is true of investing. You make your profits before you buy a stock; not after you sell it.

Core and Explore

The most important decision any farmer makes is what to plant. The price of vegetables could vary widely from year to year, and many farmers would play a Green Acres version of roulette by trying to anticipate what the “hot” vegetable of the year would be.

Not my father; he stuck to red radishes and green onions for roughly 80% of our farm and gambled with the last 20% of our land on what crops he thought could deliver big payoffs.

I do the same with my portfolio today; I keep the vast majority of my portfolio in stable, established blue-chip companies that pay generous dividends and use the last 20% or so for more speculative bets (including shorts and put options).

Profits, Not Revenues

What makes one farmer more successful than the other? Many of our neighboring farmers also grew radishes and onions, but what made my father more successful than others was that he knew it isn’t how much you harvest, but how much profit you make on what you do grow.

My father was a very frugal man, and he seldom bought anything if it wasn’t on sale, so his cost was lower than most of his competitors’.

I’m a cheapskate too, so I seldom buy stocks unless they go on sale. You’ve probably heard the warning, “Don’t try to catch falling knives.” Well, I love falling knives, and I think that I’m one of the best falling-knife catchers in the world, so you won’t see me buying stocks at 52-week highs.

Plow Under Your Mistakes

Sometimes things just went wrong on the farm. Insects would infest our crops, some months were too wet and triggered mold outbreaks, and some years frost would come too early or too late and damage the crops. Instead of spending too much time and/or too much money on rescuing the damaged crops, my father would often plow them under and start over.

My father was a big believer in cutting your losses and moving on. The same applies to investing, but I find that many investors are too stubborn to admit a mistake or want to wait until they “break even” before selling.

Expect Storms

Whether or not my father had a good year depended on three things: (1) no late frosts, (2) no early frosts, and (3) no natural disasters like hail storms, tornados, droughts, or massive insect infestations.

While you can’t avoid disasters, you can plan for them and run for cover when they do come. The wise investor diversifies in anticipation of those things that are beyond his control and buys insurance to protect against catastrophic losses.

If the stock market turns ugly (which I believe it will), how prepared is your portfolio for catastrophe? If you’re worried, you might want to check out my monthly newsletter, Rational Bear (try it for 3 months with money-back guarantee).

Tony Sagami
Tony Sagami

30-year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here. To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here. The article Connecting the Dots: Investing Lessons from the Farm was originally published at mauldineconomics.com.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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