If It Seems Too Good to Be True…
Boy, we are a really long way from this past April when the stock market was tanking and everyone was trying to remember what a tariff was and what possible harm it could do. The 12% drop in the S&P 500 in a single week following “Liberation Day” was nothing to sneeze at; and anything but liberating. Since those early spring woes, the S&P 500 has surged by approximately 20%, and the NASDAQ by about 28%, even with the pullbacks this week. How things can and do change.
Of course, it doesn’t matter if we are in a bear market or a bull market, there’s always room for fear. April’s fear was a big market drop. Here in August the fear is an overvalued market. Even though I am an experienced financial planner, I have the same emotional reactions that you have when I peek at my investment portfolio. Things seem…well…almost too good to be true.
With almost perfect timing, last Friday I stumbled upon an essay by the noted economist and author, Burton G. Malkiel. Best known (at least in my mind) for his must-read book A Random Walk Down Wall Street, which was published almost 50 years ago, Malkiel wrote a piece in the New York Times last week entitled “The Stock Market Is Getting Scary. Here’s What You Should Do.” It’s a great read if you wish to settle yourself down. I’ll save you some time and set forth the gems in the article:
- There are several identifiable risks in the stock market currently, and probably as many unidentifiable risks. We also have serious budget issues that may not be getting the attention they should be. Despite these facts, Malkiel does not suggest slashing the amount of common stock you have in your portfolios. Making investment decisions based on guesses about whether stocks will go up or down in the short-term is a recipe for poor results.
- Moving any money to cash based on current asset levels amounts to timing the market. To be a successful market timer, you have to make two correct decisions: First, when to get out, and second, when to get back in. Every study comes to the same conclusion: trying to time the market ultimately ends in poorer results than staying the course.
- To provide perspective and reinforce the market timing point above, Malkiel reminds his readers that an investor who bought a US stock market index the day after Alan Greenspan coined the term “irrational exuberance” in December 1996 – a time of huge market valuations – earned an average rate of return of almost 10% per year over the next 20 years with dividends reinvested.
- Whatever funds you have committed investment-wise to the long term should stay invested and ride out this “too good to be true” bull market rush. That said, you should focus on revisiting potential changes on any invested money that you will need relatively soon (e.g. in the next 2-3 years). Mikael recommends safe short-term bonds.
- You should also make sure that your portfolio hasn’t become overweighted in stocks versus bonds simply from the market increase. For my clients, we rebalance according to objective asset allocation rules, so we never get too far out of balance. If you are not exposed to that type of service, then you may want to check your asset allocations because if they don’t match your risk tolerance you may not be able to stay disciplined during a substantial market correction.
- Young investors should not blink an eye at this frothy market valuation. Keep pushing money into your investments and stay aggressive. The most powerful tool in your investment tool kit is time to ride out market volatility.
Many people think about being disciplined and staying the course when the market is down. These days you can see that the discipline applies on the other side of the spectrum when the market is making a large advance. Check your emergency funds. Check your asset allocation. Condition yourself for the inevitable market drop. But remember, over the long term it’s very hard not to grow your wealth with equities.
Fun fact: I couldn’t help but smile at a great quote Malkiel referenced about all the worries that exist in our economy, politics, and world events. Despite all that, as Americans we do generally find a way to land on our feet and as the old saying attributed to Winston Churchill goes: “Americans can always be trusted to do the right thing once all other possibilities have been exhausted.”
