Don't Get Blindsided by Your 'Uncle Points'

The Weekend Edition is pulled from the daily Stansberry Digest.

Your financial adviser will never tell you about "uncle points"...

But as you'll see in today's essay, not knowing about them could crush your life savings.

These days, it might seem like the good times in stocks will never end. Perhaps bear markets are as extinct as the woolly mammoth, the Tasmanian tiger, or the West African black rhino.

After all, stocks keep pushing higher with little hesitation...

The benchmark S&P 500 Index is up about 11% since early October. It recently hit new all-time highs on eight straight days – the longest streak since 1997. And of course, many individual stocks are doing much better than the broader indexes.

But it's important for us to have this discussion right now... because you must be ready for uncle points at all times. You never know what's lurking around the next corner.

With that in mind, let me do what your financial adviser should be doing...

We'll start at the top with the most basic question you could ask on the topic...

What is an uncle point?

An investor's uncle point is the moment at which he can't take any more losses on a position. Instead, he finally decides to get out in fear of losing whatever he has left in it.

In other words, it's when the investor cries "Uncle!"

It's one step beyond the maximum amount of emotional pain that an investor can stand when holding a position – or maybe even an entire portfolio – that's declining in value.

When you hit your uncle point, you're not thinking... You're just tired of feeling bad about your investment, and the only cure is to exit the position as fast as possible.

While the definition is easy to grasp, things get more muddled after that...

One major problem with uncle points is that you mostly can't tell ahead of time where they'll be...

We humans often let our emotions get the best of us.

No matter how much you tell yourself in advance that you'll be ready for anything, when the rubber meets the road and a position starts dropping, all that preparation often goes out the window.

In turn, you start thinking irrationally... You start panicking, and you don't know if you'll sell out for a big loss when you're down 59%, 95%, or somewhere in between.

It's hard to predict how you'll feel about almost anything in the future. Adding money and the uncertainties of the financial markets into the mix only compounds that problem.

You can't predict where your uncle points will be... but it's essential that you acknowledge they exist.

I realize that many of you probably don't have all your eggs in one uncle-point-exposed basket...

You likely have contributed to your 401(k) plans for years. And you've likely achieved a great long-term result – including riding out bear markets without panic-selling everything you own.

These set-and-forget retirement accounts are an excellent way to get past uncle points and build long-term wealth. But you surely aren't passive with all of your money...

You're actively managing at least one account, maybe more. You're looking at new trading ideas every day. You're spending lots of time logged into your brokerage account, with your hands never far from the "buy" and "sell" buttons... always thinking about what to do next.

Most folks who actively manage an account won't behave like a Buffett-style, long-term, buy-and-hold-forever investor in great businesses that they never sell for decades.

Instead, most active investors eventually do what human nature tempts them to do... They let their emotions influence their decisions.

That's usually not good. And as a result, they're in danger of getting blindsided by an uncle point they don't know (or admit) exists.

If you want to see what an uncle point looks like, consider the example of Peloton Interactive (PTON)...

Shares of the fad exercise-equipment maker soared 758% from March 2020 through their January 2021 peak. COVID-19 lockdowns prevented folks from going out to their local gyms, which caused sales of home exercise equipment to skyrocket.

That's mostly behind us now, though...

Peloton's stock peaked at more than $167 per share in January 2021... And it had fallen to about $86 per share on November 4, when the company filed its latest quarterly earnings report.

Slower revenue growth spooked investors. The company cut its annual sales forecast by as much as $1 billion. That's when scores of Peloton shareholders hit their uncle point...

Peloton's stock plunged 35% the following day to $55.64 per share. And it kept falling from there.

This is a classic example of an uncle point. You can see the precise moment where prices fell off a cliff below...

One way to minimize potentially devastating uncle points is to know the difference between investments and speculations...

If you've bought any financial asset in the past year or so, it's much more likely to be a speculation than when you've bought at most other times throughout history. I suspect many of you own stocks or options that you're not really sure when to sell...

That is a speculation.

Investment returns come from the intrinsic earnings power of an asset. In stocks, that means the (hopefully growing) earnings power of the business.

A true investor stays invested based on the fundamentals of the business, not the action of the company's stock price.

Meanwhile, speculative returns come from selling an asset at a higher price than the speculator initially paid. Most speculators will exit a position based solely on the price movement, regardless of underlying fundamentals.

Many strategies fall under the basic headings of "investment" and "speculation"... But generally speaking, it's accurate enough to say that investors bet on longer-term fundamentals, and speculators bet on shorter-term price movements.

When the stock market goes up very high, very fast – like it has since March 2020 – it makes getting rich off of speculations seem effortless. Investing takes a back seat as speculating causes prices to run up well beyond any reasonable valuations.

During times like this, even the most experienced investors might not be able to tell investing from speculating...

Buffett wrote about this idea in his 2000 letter to Berkshire Hathaway shareholders...

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money.

He went on to say that "normally sensible people" behave like Cinderella at the ball...

They know that overstaying the festivities – that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future – will eventually bring on pumpkins and mice.

But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight.

There's a problem, though: They are dancing in a room in which the clocks have no hands.

Nobody knows when "midnight" – the top of a speculative frenzy – is... So in turn, nobody could possibly know when it's "just seconds before" that.

If you just made 10 times your money on a position, you're probably not thinking about your uncle point if the stock were to then fall 50% while you're holding it. Therein lies the problem...

The moment you find yourself holding a rapidly accumulated multibagger return on a mediocre cyclical business is exactly when you need to start thinking about how quickly it all could disappear.

It's human nature to feel better and better about a company's prospects solely because the share price goes up...

The market couldn't possibly be that wrong... could it?

It could. And during a speculative frenzy, the market frequently is that wrong.

Part of the problem with stocks like Peloton is that folks are betting on lousy businesses as if they're the next Apple...

The story of Apple likely influenced investors in Peloton. The consumer-electronics giant makes great products whose users absolutely love them.

And so does Peloton... By all reports and appearances, the company makes products its most avid users are totally in love with.

But that's as far as the similarity goes.

Peloton is not Apple. Its exercise bikes and treadmills are hooked up to the Internet, which allows users to participate in live exercise classes... But they aren't exactly iPhones, which revolutionized how we communicate, shop, work, entertain ourselves, and more.

Peloton's hypergrowth is flagging, and it has failed to attain consistent profitability. Meanwhile, Apple gushes so much cash profit that it doesn't know what to do with it all.

This isn't a new problem for investors, of course...

Value guru Ben Graham, Buffett's mentor, commented on the problem of getting too excited about lousy businesses during booms in his classic book, The Intelligent Investor...

he chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

The purchasers view the current good earnings as equivalent to "earnings power" and assume that prosperity is synonymous with safety... It is then, also, that common stocks of obscure companies can be floated at prices far above the tangible investment, on the strength of two or three years of excellent growth.

In terms of Peloton, folks viewed its rapidly rising sales as something more than a temporary effect. Like Graham said, it made them feel like Peloton was a safe stock to own.

With the stock market in full frenzy mode, plenty of Peloton-like stocks exist today... And each one comes with its own band of naïve speculators totally unaware that they're holding one-way tickets to their uncle points.

The pandemic created a new generation of investors – speculators – who have flooded the markets...

They have never been through a real bear market before... And they've never stepped around a corner and been mugged by their uncle point.

You, me, and every gray-haired investor who went through the last financial crisis, the dot-com crash, and any other market unpleasantness have seen this movie before...

We've all done battle – successfully or unsuccessfully – with our uncle points. We've all been that newbie investor who did everything wrong and lost money. We've all suffered and learned.

And the reality is, the current crop of newbies can't avoid that painful learning experience indefinitely.

Therefore, it's reasonable to assume that all these folks who've never endured an extended run of falling stock prices, hit any uncle points, or taken any catastrophic losses are not ready to deal with any of those calamities in the coming weeks or months.

And they're likely to deal with the ugly side of investing in a Murphy's Law fashion... Whatever they can do wrong, they will do wrong.

Little do these folks know that "Uncle Murphy" is always one step ahead of them... They're totally unaware that by simply making a ton of money fast, they're already halfway to his house.

Uncle points and the avoidance of catastrophic losses are why every Stansberry Research editor or analyst guides folks to use trailing stops or some other risk-management tools as part of all their recommendations...

You're only human, after all. Your emotions will always get in the way of sound decision-making. And if your investment strategy doesn't reflect that, you're doomed to face Murphy's wrath.

That's why it's important to avoid uncle points at all costs – and in turn, keep them from destroying your wealth...

But as an investor, how can you do that?

First... have at least some part of your wealth in a place that you rarely interact with.

For example, let's go back to your 401(k) account. If you already own shares of an exchange-traded fund that tracks the S&P 500, that's great. You should just keep contributing to it regularly and never look at it.

And of course, if you're not already doing that... there's no better time to start than today.

Second... always implement a well-defined exit strategy – and more important, adhere to it religiously for all the money that you actively manage.

You're most likely to speculate in those accounts... and get mugged by Uncle Murphy.

To prevent that from happening, decide when you'll get out of an investment before you get into it. All good traders and investors employ a well-defined exit strategy with every position in their portfolios. So if you don't do that, maybe this investing thing just isn't for you.

And third... hold a truly diversified portfolio.

That includes long-term investments in well-chosen equities, plenty of cash, some gold and silver, and maybe a little bitcoin. By spreading your wealth around, you'll limit the chance of one uncle point wiping out everything you've worked so hard to build.

In the end, just knowing about uncle points will be a major step in the right direction for a lot of investors.

And the good news for you is... every Stansberry Research editor knows about uncle points.

They all build protections against that type of risk into their investing strategies. That's true whether they operate with a short-term mindset... a long-term one... or somewhere in the middle. And if you do the same, you'll be far better off in the long run.

When it all comes down to it, our mission is to help you stay far away from Uncle Murphy.

Good investing,

Dan Ferris

Editor's note: We've been riding a historic market rally since the pandemic crash in March 2020... But now, Steve is urging you to prepare for the Melt Down in stocks that he sees ahead. As Dan warned today, you don't want to "get mugged by Uncle Murphy" when this bull run changes course. So if you don't already have an exit strategy for what's ahead, you need to take one important step now... Click here to get started.