I believe investing for income is the best way to avoid the risk of getting crushed in a market exit.
What do I mean by exit crush risk?
Portfolio Insurance Caused Black Monday
Here's a good example: in the early 1980s some genius got the idea to create and then sell to fund managers "portfolio insurance."
However, the word "insurance" was used very loosely and inaccurately. Ordinary insurance works by spreading the cost of risk around to many people. Portfolio insurance seemed to guarantee institutions such as pension funds that they escape general market downturns.
Basically, the program was a form of software that continuously monitored the market prices of every stock in the fund's portfolio. If they dipped below a certain level, the program automatically placed a sell order to reduce the fund's risk by reducing its exposure to that security.
One Fund Doesn't Move the Market, but When They All Sell At Once . . .
Now, in isolation, that's a great idea. Some people could argue that if the stock is good, then buying upon a dip in price is a better idea, but they don't have to answer to committees and boards of directors and shareholders who withdraw their money at will. Fortunately, the rest of us don't have to meet quarterly goals.
And so for a few years, portfolio insurance worked. If your fund owned AT&T and that company's stock went down below a certain level, the program automatically started selling, reducing your risk.
However, on October 19, 1987 the market itself went down enough to trigger the sell orders on many stocks held by many funds.
Stocks are subject to the economic laws of supply and demand. When supply goes up, prices go down.
So very quickly the market prices of these stocks went down, driven by the automatic selling of these funds.
The First Selling Caused More Selling
And it was a vicious cycle. As the prices of the stocks went down, the software automatically issued even more sell orders, driving the prices down even further.
Many individual investors wanted to add to the selling pressure by dumping their stocks, but couldn't because phone lines were tied up.
This porfolio "insurance" worked for one fund, but when all of them had it, it drove down the entire market -- 22% in one day.
Every fund was racing toward the exits.
One Mortgage Default is No Problem, but When Millions are Behind . . .
Something similar happened in the sub-prime mortgage crisis of 2007-2008 with the mortgage-backed securities.
The financial institutions which packaged, sold and bought them counted on American mortgage owners to pay their monthly house notes.
Mortgage-Backed Securities Have to be Marked to Market, Fair or Not
When foreclosure rates went up all over the country, suddenly everybody realized this was the first national real estate bubble. Suddenly even mortgage bonds that were still returning interest were worth a lot less on the market, and had to be marked down, dragging down financial institution balance sheets all over the world.
In the October 1929 Crash, the 10% margin rate increased the exit crush risk. Everybody had to sell because they had no equity in their accounts, which lowered prices for the whole market.
How do you escape the general panic during such situations?
Nobody Has Figured Out How to Avoid These Occasional Panics
Don't buy for capital gains. Then you don't care what the market price of your stocks are. So you hang on while everybody else is charging for the exits.
When you're investing for incomes, you don't want to sell unless the income stops.
Author Resource:
You can amass a retirement portfolio of income producing securities. Click here to get the information you need to effectively make money from your investments whether the markets go up or down. If you're ready to discover how investing for incomes can help you retire with financial security, visit this page, enter your email address into the form and click on the Submit Button. Then go to your inbox and verify that. It's free for the taking. http://www.incomeinvesthome.com/.
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