Many investors, particularly those who manage their own brokerage accounts and trade aggressively, depend on stop-loss orders to protect their investments. But do stop losses make sense for longer-term investors whose portfolios are managed by financial planners? It depends.

“Most investors are not even familiar with stop losses,” says Walter Pardo, founder and managing partner of Wealth Financial Partners in Basking Ridge, N.J. “Many of them just assume that advisors are automatically going to protect them. That is, if the market goes down, they assume that the advisor will do something on their own to get them out of harm’s way.”

Stop losses can be useful for clients who have volatile positions with significant risk/reward profiles, says Jeff Dvorak, CFP and managing principal of 4D Financial Advisors in Naperville, Ill. “They can also be valuable for investors who travel a lot or are otherwise unable to monitor their positions throughout the day,” he says.

Jim Hallett, an advisor in Port Angeles, Wash., says the tool has both advantages and disadvantages for advisors. “The benefits of stop losses are that clients have some certainty of a plan of action, and the downside decline in value is minimized. … [But] one drawback is that, if the stops are too narrow and the stock has price-range fluctuations that are relatively wide, the stock could be stopped out during a temporary period of short-term volatility.”
beware volatility

Dvorak adds another disadvantage: If a stop loss is triggered during a spike downward in the market and then equities recover, the investor would miss out on gains.

Yet another concern is that stop-loss orders don’t guarantee “to the penny” sale prices. For example, if an order is set at $90, it might actually not sell until the price falls to $89.85. (Indeed, in certain cases, the gap might be even greater.)

And Pardo adds one final caveat: “You need to cancel stop losses if you sell the stock prior to the stops triggering.” That is, if you buy a stock at $100 and set a stop loss at $85 but, in the meantime, sell the stock at $90, you must cancel the stop loss. Otherwise, he says, you’ll have an open order to sell a stock you no longer own.


Stop losses are particularly good for clients who have large positions, sometimes as a result of having accumulated a significant amount of employer-awarded stock, says Jeff Rose, CEO of Alliance Wealth Management in Carbondale, Ill. “We recently put stop losses on some stocks for one of these clients, because he didn’t want to go through 2008 again,” Rose says. “We figured his bottom dollar on each stock — and, actually, two of those triggered in mid-October.”

Pardo doesn’t recommend that clients hold individual stock positions — but some clients ask for them all the same. That’s when he says stop losses come into play. 

“When clients do want to use me for that, and ask me to purchase specific stocks for them, I will also suggest stop losses if the clients make it clear that they don’t have the time to keep track of the stocks on a regular basis,” Pardo says. “It provides some discipline on what they are trying to protect on the downside.”

Boston planner Jennifer Lane, founder of Compass Planning Associates, sometimes suggests clients use stop losses in so-called fun accounts — in which they are buying stocks that hold particular interest for them, or are speculating — if they are holding more than she would prefer of a single stock.

“These fun accounts aren’t figured into the assets needed in order to meet the client’s financial goals, so the stop losses are mostly to protect against the risks of holding the individual stocks,” she says. But it’s up to the clients to activate the strategy, she adds: “Clients manage their own fun accounts.”

One way an advisor can help is by recommending a price target to set. “Investors can often get emotional with certain securities,” Dvorak says, “and part of my responsibility is to provide the discipline to remove the emotion and make decisions based on the facts.”

“In terms of setting stops, I let the clients do that,” Pardo says. “However, I will give them the ranges of where the stocks have been trading. If I do that, I charge them a bit more because I am involved with them in my fiduciary responsibility.”

Mike Berry, founder of Legacy Wealth Management in Grand Junction, Colo., says he and his clients work together to come up with high and low targets on which to base stop-loss orders. “Clients want my input, but I also want theirs,” Berry says. “I want to know what range they feel comfortable with in terms of taking a potential loss.”

Berry also works with clients on setting stops on the high end in order to take gains. “I believe in the old saying, ‘Pigs get fat, but hogs get slaughtered,’ ” he says. “We don’t want to get too greedy and go for the last nickel.”

For Berry, the only costs typically associated with stop losses are the usual ticket charges that must be paid when clients buy and sell stocks.


Advisors who outsource their asset management may be able to get additional tools. Rose uses an asset management company called FormulaFolios, which offers a feature called AssetLock.

“It allows you to put a stop loss on a client’s total portfolio, even if it includes mutual funds,” he says. “I have started to use this feature recently. The client and I go through a risk questionnaire to determine at what number they want to get out. I provide some guidance; however, ultimately, I put it back on the client.”

He and the client agree to a number where they want to sell — no matter what — and when the portfolio is close to that number, the client and Rose both receive a notification from AssetLock. They can readjust then if they want to, or stick with the original.

“If the number is triggered, we get out and automatically go to Treasuries until there is a specific economic indicator that we use in order to get back in,” Rose says. Of course, if mutual funds are included in the portfolio, the sale is triggered at the end of the day.

Clients like the AssetLock feature, according to Rose, because it takes some of the emotion out of investing. Rose notes that while FormulaFolios has its own advisory and trading fees, there are no additional charges for the AssetLock feature.


Some planners who consult on stop-loss decisions say they have broader concerns. Lane says she prefers to steer clear of individual stocks and related tools, and instead stresses the importance of diversification, asset allocation and disciplined rebalancing.

Dvorak is adamant about not recommending stop losses to clients. “One of the biggest discussions with a client is about the appropriate asset allocation for them based on their financial goals,” he says. “Once this has been agreed upon, all of the investment vehicles we select have a specific role within the portfolio.”
He prefers that most clients remain unfamiliar with the concept of stop losses, as they are often irrelevant for the average investor. “We use vehicles for which we thoroughly understand the strategies,” Dvorak says, “as well as the risks.”FP

William Atkinson is a financial writer in Carterville, Ill.

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