122 Crash Profits: Make Money When Stocks SinkandSoar
“Sounds too good to be true.”
“It’s true all right but not always so good. If the market goes up, you lose. If the S&P rallies 20 percent and you have a fund that’s the reverse of the S&P, then your fund goes down 20 percent.
Meanwhile, though, at that point your grandfather’s shares would probably be going up. Maybe not dollar for dollar, but close.”
“I know what you mean,” she said with complete understand- ing. “It won’t be a perfectly balanced seesaw. The fulcrum may be off-center.”
She felt very content, and the adviser promised to give her the name and phone number of some of the reverse index funds, plus a set of instructions on exactly how much, where, and when to buy.
Linda breathed more easily. Until now, she had felt naked with- out some kind of protection. Now that she knew how to cover her- self, she could sleep nights. She vowed to act on it as soon as she got home.
“I’ll send you the details in a file attached to an e-mail,” he said.
“I’ll call it ‘Crash Protection.’ Check it out, and if you have any ques- tions, let me know. Gotta run now. I have a dentist appointment—”
“But wait!” she exclaimed before he hung up. “What about the investment that can turn $150 into $800? What about helping us recoup our losses quickly?”
“First, take care of your defense—crash protection. Then, as soon as you’ve got that licked, call me back in a couple of days.
Depending on your finances, you can go on the offense and aim for crash profits.”
The Winning Minority 123
Index mutual funds are more restricted. The managers’
job is strictly to buy stocks or other instruments to match, as closely as possible, the performance of a particular stock market index, such as the Dow Jones Industrials, the S&P 500 or the Nasdaq 100. Reverse index mutual funds use the same principle—but in reverse. Instead of helping you make money when the market goes up, they are designed to help you make money when the market goesdown.
They invest a good portion of your money in safe instruments, such as Treasury bills, to generate interest income. Plus, they allocate a portion to investments, such as futures and options, that appreciate as the market goes down, balancing the exact quantities of these instruments so that
■ There is always enough cash and equivalent in the fund to cover any losses. You cannot lose more than you invest.
■ The fund matches the performance of the index in reverse. If the market goes down, you will make a profit; if the market goes up, you will incur a loss.
Some examples:
Rydex Ursa (RYURX; www.rydexfunds.com, 1-800- 820-0888). This fund is designed to appreciate 10 per- cent for every 10 percent decline in the S&P 500 Index.
Here’s how it works: The Rydex Ursa fund basically maintains an open short position in the near-term S&P 500 Index using the futures markets. But these positions are fully collateralized with Treasury bills and various money market instruments, earning interest. The interest income helps cover transaction costs, operating expenses, and management fees.
Whatever income is left over gets paid out as a divi- dend. This dividend also helps cushion somewhat the decline in net asset value during periods when the stock
(Continued)
124 Crash Profits: Make Money When Stocks SinkandSoar
market is rising. During periods of market decline, it can help enhance your gains somewhat, depending on inter- est rate levels.
Warning:When you buy this fund, you are betting on declining stock prices. If the markets go up instead, you can lose money.
Rydex Arktos (RYAIX; www.rydexfunds.com, 1-800- 820-0888). This is structured the same way as the Rydex Ursa fund, with one critical difference: Instead of tracking the S&P 500 Index, it tracks the Nasdaq 100. For every 10 percent decline in the Nasdaq 100, the fund is designed to appreciate 10 percent. Since the Nasdaq 100 Index tends to be more volatile than the S&P 500, the fluctuations in this fund’s shares will also be more volatile.
That means higher potential profits but also higher risks.
Profunds (www.profunds.com, 1-888-776-3637). Sim- ilar funds that are essentially clones of the Rydex funds.
Step 2: Evaluate your remaining stock portfolio. Is it almost entirely tech stocks? Or is it mostly blue-chip and other stocks, with just a small amount of techs?
If you have blue-chip or other stocks that you can’t sell, consider placing a modest portion of your money into shares of the Rydex Ursa fund or equivalent. That way, if your stock portfolio is falling, your Ursa shares will be rising, helping to offset the loss.
If you have a large portfolio of tech stocks that you can’t sell, you should buy shares in the Rydex Arktos fund. That way, even if your tech stocks fall still further, at least your Arktos shares will be rising, helping to offset the loss.
Step 3: Estimate your risk of loss. No one knows for sure whether the stock market is going up or down—let alone how much or how quickly. But based on recent history, it is not unreasonable to assume that a stock portfolio could fall 50 percent. If your portfolio is worth about $100,000 at
The Winning Minority 125
one time, your risk, in this scenario, will be $50,000; If you have $50,000, your risk will be $25,000; and so on.
Step 4: Decide how much of that risk you want to pro- tect yourself against. If you wanted to protect yourself against the entire amount, you’d have to invest about dol- lar for dollar in one of the reverse index funds. If that is too much, consider covering half your portfolio. Then, for every $1 of current value in your stock portfolio, you would simply put 50 cents of your money into the appro- priate reverse index fund (see Step 1). Assuming that your stock portfolio is worth $100,000, you’d be investing about $50,000 in the fund.
Step 5: Raise the funds for your crash protection pro- gram. Where do you get the extra $50,000? You could take it from your cash assets. But if you did, you would in effect be moving money from a safe investment to a more aggressive investment. That may not be prudent.
Instead, a prudent alternative is to liquidate at least enough from your remaining stock portfolio to finance this program.
The formula is simple: If you want a program that will protect you against half your risk, and you don’t want to take money from another source, you should liquidate one-third of your shares to generate the money.
I
t was a sad, tense time for econo- mists on Wall Street and in Washington.Until recently, they had assumed that a long-term recovery was locked in, virtually guaranteed. Not one prominent economist veered significantly from this theory, and those who did either kept silent or were told to shut up.
In public, they were touting the economy’s “fundamental strength.” In private, however, they were biting their nails to stubs.
One of the few vocal dissenters was Tamara Belmont. Several months earlier, while still at Harris & Jones, she had debated fre- quently with fellow analysts. But she had been frustrated by the rules of the game: Although it was OK to talk about a future reces- sion in private conversations, any material for distribution was severely restricted, especially if it could fall into the hands of the public. Recession talk was considered bad for business.
Tamara had a very tough time buying into those rules. Her ancestors were related to a famous bullfighter in Spain. She was not about to back down from the infamous bulls of Wall Street.
Her fundamental argument was not radical: A recession isn’t completed until it corrects its own causes, until it cleans out most of the excesses piled up during the preceding boom. Those include
126