By now most portfolios have finally recovered to the levels of the last market high in October of 2007.
The major market averages have moved above the October 2007 levels and we are now riding a wave to all-time market highs.
The NASDAQ average has yet to break its prior high set in the year 2000, but it is within striking distance. Investors should be euphoric about these developments, yet they are not.
Fear seems to be the operating psychology among investors, especially those in or nearing retirement. The questions I am getting relate to when this rise in stock prices will end.
We in the investment community have seen exceptional efforts by governments and central bankers to mitigate the effects of the 2007-2009 economic collapse. The financial industry crumpled because of the pursuit of short term profits, continued earnings growth, and the over-extension of financial leverage coupled with a blindness to the eventual outcome.
The stimulus continues, with a zero interest rate policy in the United States plus quantitative easing in Europe and Japan and further monetary stimulus in the former great growth country of China. All of these policies have mispriced money to the downside and have also prevented those who are retired or have an interest in retirement from earning a reasonable return on their accumulated capital. The situation is so dire that the fear of running out of money in retirement trumps all other fears for many Americans.
So what is an investor to do as the stock market surges ahead? The answer is get out of the investment markets when it starts down the other side or when the bull market ends. The two questions I get after that statement are, “how do I do that?” and “then where do I invest my money?” The answer to the first question is rather simple and requires that you pay close attention to your portfolio, at least the total value every week. Let me set the stage:
Make sure all your investments are priced daily and you are able to sell them on any day the market is open for business.
Diversification may not provide much safety in a major market downturn as all asset classes tend to decline together. The coefficient of price correlation tends to go to 1 in sharp market downturns. Diversification is of value in mixed markets and rising markets.
Do not rely on guarantees from companies or other entities. Guarantees are only as good as the investment acumen of those making the guarantees and eventually all guarantees will fail. Don’t let them fail for you.
Pay close attention to the total value of your portfolio noting the value versus several moving averages of the total value of your portfolio.
With this background in mind, plot the value of your portfolio either on a graph or in a column of numbers. Next to your plot, calculate the moving average from 20-day, 50-day and 200-day moving averages. When the value of your portfolio declines through the 20-day moving average, pay closer attention and be cautious.
When the total value of your portfolio falls below the value of 50-day moving average of your portfolio, you should start selling those issues that are not adding to the positive performance of your portfolio. You can do this by noting the price of each investment versus their moving averages. Finally, in the event that the total value of your portfolio declines below its 200-day moving average, then sell most or all of your positions and move to cash. That is how you minimize the damage caused by a declining stock market or declining prices in the bond markets.
The answer to the question of where to invest the money after you sell is that you don’t; not immediately, anyway. Stay in cash until the market reverses or at least until individual investment prices begin to rise again using the 20-, 50- and 200-day moving averages as indicators. If you do not have the time or are not rigorous in the application of this aforementioned strategy, then hire someone who can do this for you.
The primary purpose of investment management is to minimize the damage caused by declining markets to allow you to stay in the investment game. After this goal is attained then you turn to earning a reasonable return. Too often investors only look to earning a return, not preserving their principal.
Even though your portfolio may currently be riding the wave of a bull market, don’t think that makes you a smart investor. Novice surfers often end up wiped out on the beach. Make sure you stay alert and get off the surfboard before the wave breaks.
That is to say, move out of the market when it’s appropriate, before you suffer a decline in value from which you may never recover.
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