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Dow And S&P 500 Are At Record Levels….So Now What?

June 13, 2013
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By Jeff Vistica

Learn more about Jeff on NerdWallet’s Ask an Advisor

Investors need to keep their focus on their long-term goals and the plans they have in place to help them achieve those goals.

Trying to predict the market’s next move can be a costly mistake.  Smart investors know that recent returns, good or bad, are simply part of the journey in pursuing their goals.  Markets are always unpredictable so your plans should account for market volatility.  A good investment plan will diversify your risks to not only give yourself a chance to capture positive returns but also to help assure you’re not taking on any more risk than you need to.

The media makes it very difficult for investors to focus on what really matters in being a successful investor. It is very easy to get caught up in the noise of the markets and want to react to the media’s messages.  Remember the media is not interested in providing you with prudent investment advice.  That is simply not their line of work.  The media is concerned with boosting their ratings and selling their periodicals. Investing done right should be about as exciting to talk about as it is to watch paint dry.  Consider that over 60 years of peer reviewed academic evidence demonstrates that buying a low cost portfolio of passively managed asset class funds and ignoring the urge to try to time when to get in and out of the markets gives investors the highest probability of reaching their long-term investment goals.  This sort of data, produced by leading academia, lacks the sizzle that boosts TV ratings; but it provides investors an intelligent way forward.

Timing when to get in and out of the market is a difficult task.  The market doesn’t provide investors with an obvious go-ahead to either jump on or off the ship.  And, getting the timing wrong is costly. Peter Lynch, the former manager of the Fidelity Magellan Fund, once noted, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”  Timing when to get out, based on the hope of outsmarting the market, is best avoided.  Lynch adds, “I can’t recall ever once having seen the name of a market timer on Forbes’ annual list of the richest people in the world.  If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it.”  

Recent market history shows that bull market cycles last longer than bear market cycles, and produce cumulative gains that more than offset losses experienced in bear markets.

Wall Street has no incentive to communicate this message because their pockets are laced by creating urgency and making you want to “act now” in the face of an ever-growing newsreel of worry.

An important distinction should be made in describing what the media and Wall Street are telling investors to do.  The practice of attempting to time the markets by exiting before a bear market begins and re-entering before a bull market charges ahead, along with relentless attempts to select “undervalued” or avoid “overvalued” stocks is referred to as the practice of active management. Active management is nothing more than speculation.   Speculation is much different than investing. A speculator is essentially placing a bet.  The bet is based on the belief that the market has mispriced a security and the speculator knows what the correct price should be.  While markets don’t perfectly price all securities all of the time, the collective knowledge of all market participants buying and selling securities leaves us with a pretty good estimate of any given stock’s value.  So with the vast amounts of market participants trading stocks daily, it is difficult to get an edge on the market without taking more risk.  Sure it’s possible to get lucky and find that winning stock.  But it is very difficult, if not impossible, to do so consistently and skillfully.  Along with the added costs of taking this approach, speculation and failed stock picking attempts are major factors as to why so many actively managed mutual funds fail to match the returns of, let alone beat, their respective benchmarks.   Outperformance is often a result of “luck” and not manager skill.  Professors Eugene Fama & Kenneth French discuss.

A common thread among smart and successful investors is discipline.  It takes discipline to stick to a well-designed and globally diversified portfolio through both bull and bear markets.  It takes discipline to rebalance your portfolio back to its target risk profile in the face of a rising (or falling) market.  Rebalancing is the practice of selling high and buying low and keeping your portfolio in line with your risk objectives. So with markets having recently done exceptionally well, it may be time to realize some excess gains in your portfolio to restore your portfolio back to its risk targets.  You should have rebalancing and tax-management protocols written into your well thought out investment plan that also considers your overall tax, estate and protection planning.

If your long-term financial goals haven’t changed, sticking to your plan and asset allocation is probably your best way forward. So what’s next? Focus on the things within your control such as your tax, estate and asset allocation policy. Rebalance your portfolio, if needed, and enjoy the recent returns.