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Wall Street is doing backflips — overjoyed — as the markets surge. Stories and reports flood the landscape with projections of sustained growth in the markets. In other words, the stories produce unfettered exuberance, spurred on by higher prices and optimism born more from wishful thinking than reality. The fact is, as you watch your account balances grow, you will use each high as your new bar for success. Well, it’s time for a reality check: History has shown us time and time again that this will end, markets will correct to fair value, and speculators will get crushed.
The discussion is not about market timing! Beware that the “pundits,” “experts,” and newsletter writers who have sold their clients on their “ability” to know when to pull out are playing a game of Russian Roulette with five chambers filled with bullets. You might get lucky and pull the trigger on the empty chamber, but the odds are not in your favor that your luck will hold out very long.
There are several key issues to consider during this time of a raging bull market:
- It’s time not timing. The amount of time your money is invested is more related to success than you might think. Unless you are a die-hard believer in winning the lottery (and you have some secret knowledge to bring in favorable results), you want to gauge your exposure to the stock market based on when you need to access these funds and how much risk you’re willing and able to take on. The longer time you have, the likelihood of growth becomes higher. In other words, if you have a short time until you need to utilize the investment, you are taking on a greater risk of failure.
- Diversification. Sure, being well and properly diversified in your portfolio sounds boring. It’s way more interesting to buy the hot stock or the hot sector with the goal of reaping excitingly high returns. However, if you ascribe to the old saying that “Man Plans and God Laughs” you might find yourself on the wrong end of excitement. Spreading your investments among many varying asset classes is more conservative and the smarter path to take if you want your investments to grow over time. Yes, the expected returns might assuredly be less than the returns delivered by the hot stock or sector, but consider how you would feel if you saw your nest egg evaporate on a wish and a prayer. Think twice before putting all your eggs in one basket.
- Understand risk. Human behavior plays a huge role in investment success, and success in general. Humans tend to feel comfortable when they feel part of something, rather than being the lone wolf standing away from the crowd. It’s that group behavior that feeds into the frenzy of “before it’s too late” syndrome. The bottom line is that there are safe investments and risky investments. One is not better than another, but you should focus on how much you hold in each, which is dependent on two factors: your time horizon and your ability to put your head on the pillow at night.
- Interest rates can’t produce the results you want. If you are waiting for interest rates to beat inflation (long term), you likely have a super long wait. Interest rates produce a return less than inflation, especially if you’re invested in short term bonds. So, is the answer to have a safe interest rate investment to buy long-term bonds? That would be an emphatic NO! Long-term bonds are extremely volatile. Locking in a bond for twenty or thirty years means that you are guaranteed that rate over that time period, regardless of where interest rates move (up or down). If interest rates fall, your bonds will most likely be called and you’ll have a lower rate bonds to choose from with the proceeds of the called bond. If rates increase (with inflation), then the value of your bond decreases and the rate you’re getting is lower than market. It’s a lose-lose scenario.
How do these issues tie into the idea of the stock market bubble bursting? I’m glad you asked.
The more you understand the markets, investments, risk and return and your own beliefs and behavior, the better equipped you are to make sound decisions. If you are invested properly for your time horizon and ability to withstand market volatility, you’ll get through the next correction without losing sleep or making bad decisions; such as selling when markets are low because of fear. This is where understanding that the crowd mentality, all the terrible news stories of doom and gloom, will prompt you to make a potential terrible decision.
If you are a DIYer, consider getting a second opinion from a fee-only advisor who will consult with you and not try to sell you anything.
If you are working with a broker who earns their living from buying and selling, that second opinion is a great idea too.
Corrections are normal, just as bull markets, flat markets, recessions. If you are following the herd in making your financial decisions, consider the cost of making mistakes and work toward a measured and well-conceived plan that will help you avoid disasters — and more importantly, put you on a path towards financial success.