The equity markets have again pushed against all-time highs. These moments tend to elicit two very different responses from investors, euphoria and fear. Some investors view this as a sign to get more money in the market and hope the wave continues moving upwards. Others see this as a sign that we are due for a pullback and start pulling money off the table. Both of these actions are emotional responses. Investing with emotion is a risky endeavor and can lead to costly mistakes.
What are some non-emotional actions you can take when markets are pushing highs and there is uncertainty about their future direction?
- Have an investment strategy and stick to it. Every investor should have an investment strategy. An investment strategy is there to keep you disciplined. It will tell you when to buy, what types of investments you will buy, and the circumstances that are acceptable to sell. Having this investment strategy will allow you to block out the noise in the markets and media and focus on growing your wealth in a disciplined and planned out way.
- Rebalance. Often when markets are performing well, there are a few specific asset classes that have been driving that performance. This excellent performance often leads to these categories becoming overweight compared to their target percentages because they have grown significantly. Keeping your asset allocation in line with its target percentages is key to long-term investing. If your equity categories are overweight, the risk in your overall portfolio has increased since these tend to be the most volatile asset classes.
There are really two way to rebalance. You can sell the category that is overweight and reallocate the proceeds to underweight categories. However, the tax implications of selling must be considered. Rebalancing in tax-advantaged accounts like 401(k)s and IRAs is easy to do, you can sell investments without having to worry about capital gains taxes. That is not the case with taxable accounts like individual, joint, and trust accounts. Selling an investment with a significant gain in these accounts may result in owing a hefty capital gains tax. For these types of accounts, the second rebalancing strategy typically works best– add more money to the account and apply that money to the underweight categories.
- Stockpile some cash to invest if the market experiences a correction. The markets will experience a correction. Knowing exactly when is impossible without a crystal ball. However, corrections do provide excellent buying opportunities, as some investments may be trading at a discount. By having cash on hand, you can be prepared for when that moment comes.
Determine an amount you feel comfortable sitting in reserves and eventually investing. When a market correction occurs, use this stockpile to invest in categories trading at a discount. Since it is impossible to know when the market has hit its bottom, use a dollar cost averaging strategy to invest incrementally over a set period of time. Buying incrementally as investments go down will allow you to get in at good prices, but removes the risk of going all in at the wrong time.
When markets are pushing highs, everyone wants to know if it can keep going or if it is due for a pullback. No one can really know for sure one way or the other. The best you can do is have a plan in place so you know how you will react regardless of which direction it goes, remain well allocated and diversified across asset classes, and have a little cash available in case a buying opportunity arises.
Jeff Witz, CFP® welcomes readers’ questions. He can be reached at 800-883-8555 or at firstname.lastname@example.org.
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