Protect your stock portfolio gains with smart strategies

If you have been investing in the stock market for the last five years or so, you know that the results have been excellent. Since the stock recovery started in March 2009, the market has increased at an annual rate of around 25 percent, through July 2014.

It is not unusual for a market drop of 10 percent or more to occur at the end of a lengthy period of stock market gains. However, no one can tell you when or if you should protect your gains in some way. How you proceed depends on a number of considerations.

If you have a stable job and more than 20 years before retirement, and you have a diversified common stock portfolio, there is no compelling reason to sell your common stocks, whether they are in mutual funds, exchange-traded funds, known as ETFs, or individual securities.

On a long-term basis, common stocks should do better than bonds or other conservative investments such as CDs, savings accounts and money market instruments. You should maintain a significant percentage of your portfolio in common stocks. Even if there is a short-term fall in stock prices, time is still on your side. In the long run, as long as you maintain a diversified portfolio of common stocks, you should be able to stay ahead of inflation and have a prosperous retirement.

If you are retired or close to retirement, it is important to have a balanced portfolio, with a significant proportion invested in bonds. Balancing is important. I do it at least once a year. If you have not balanced your portfolio recently, it is likely that the proportion of common stocks has increased relative to bonds. For example, assume that a few years ago you determined you wanted your portfolio to be 60 percent stocks and 40 percent bonds.

Because of the increase in common stock prices, your portfolio now might be 70 percent stocks versus 30 percent bonds. It would be prudent to sell some of your stock holdings and go back to a 60-40 ratio. In that way, you are protecting some of your gains in case there is a general fall in common stock prices.

It is hard to predict Federal Reserve policy. However, with interest rates as low as they are, it is likely they will trend upward. Thus, it's prudent not to have the majority of your bond holdings in long-term issues. If long-term rates increase substantially, long-term bonds, even Treasurys, will fall substantially in value. I maintain most of my holdings in intermediate-term bonds (both in mutual funds and ETFs).

In this way, I receive moderate income without a great deal of capital risk if long-term rates increase a great deal. If you have short-term needs, such as tuition payments or a down payment for a home, then you should keep these funds in short-term investments, such as short-term bonds, Treasury bills and money market instruments.

If you have substantial investments in individual common stocks that have increased greatly in value, you have other options. The most conservative is to sell all of your shares and conserve all your profits. However, if you are confident that the underlying company will continue to increase its profits, and the stock will continue to do well, you can sell some of your holdings and reinvest the proceeds in more conservative vehicles such as diversified mutual funds or ETFs, or intermediate-term bonds.

Another alternative is to use a stop-loss order. That's an order to sell a stock that is triggered when the share price reaches a specified level. For example, suppose you bought a stock at $20 per share. It is now selling for $38. You think it will increase more in value, but you want to protect some of your gains. You can put a stop-loss order at $35. If the stock does fall to $35, your shares will be sold at prevailing market prices. If the stock continues to increase in value, you can cancel your previous stop-loss order and place a new one at a higher price.

If you have done well in the stock market, congratulations. If you want to protect your gains, however, you should consider some of the options discussed. Common stock prices don't always go in one direction.

Elliot Raphaelson is a financial columnist for Tribune Content Agency.