Wow, the market is pretty hot right now with valuations at all time highs. Data suggests small investors are jumping in with both feet. A recent WSJ article quoted Martin Small, head of U.S. iShares, as saying 85% of their exchange traded funds’ inflows so far this year have been from individual investors.
There is an old saying: When your dentist starts buying duplexes, it’s time to get out out of the real estate market. I have nothing against dentists or small investors, my point being: euphoria is the fuel of market cycles. Many of us can remember back to the dotcom days, when every IPO or technology stock was considered a sure thing until the bottom suddenly dropped out. In 2008 it was the same scenario, only different, and more devastating. What will our next correction look like, and when will it occur? Nobody knows, but here are some of my thoughts on how to invest properly during the upside of a market cycle:
- Minimize debt. If rates rise and valuations fall, leverage can become your worst nightmare. Keep the debt side of your balance sheet at a reasonable level so you don’t have to liquidate undervalued assets during a correction.
- Maintain cash reserves. Along the same lines as minimizing debt, cash reserves allow you to remain long on investment assets THROUGH market downturns. Nothing protects a good investment portfolio better than cash reserves for short term liquidity needs.
- Re-balance. There is no better time to re-balance a portfolio than when valuations are high. We are maintaining strict allocation tolerances in our clients’ portfolios to take advantage of profits and protect against future losses.
- Maintain discipline. If you are considering a more aggressive posture in your portfolio, be patient and wait. We have several clients identified for higher equity position allocations, but we’re waiting until valuations become more enticing to make any moves.
Our emotions are our greatest enemy when it comes to investing. The “feeling” we may get about future market swings should generally be ignored. The complexity of the stock market, with millions upon millions of data points and risk factors, can be beyond our full comprehension. However, we know from past data that the market does not move in a straight line. When the market is at levels we perceive as premium valuations, it’s good to review and adhere to these basics of downside protection.