Two Strategies To Implement In Good Markets
Many investors are starting to get their investment statements for the first quarter of 2012. Have you opened your own statement yet? If not, go ahead, it’s probably good news. Wow, what an incredible start to the year the stock market had! The S&P 500 gained 12.6 percent (total return) during the first quarter of 2012. The last time the stock index gained at least 10 percent in the first quarter was 1998. (source: BTN Research). Two strategies the average investor can learn from the past to make smart financial decisions about the future are to rebalance and avoid chasing performance.
The problem for many investors is that when everything appears to be going well, it is easy to become complacent or worse yet, to chase performance. Remember, the past is history, it’s done and over with. Instead, apply what has been learned from the past to making better investment decisions in the future. Investments that went up recently already went up, and that doesn’t mean those investments will keep going up in the future. Remember how good technology stocks were in the late ’90s before the 2000 crash? Or how easy it appeared to be to make money in real estate in 2007, before the 2008 crash? Mark Twain once said, “History may not repeat itself, but it does rhyme a lot.”
If history continues to repeat itself, the stock market could do great the rest of this year. According to www.seasonalcharts.com, from 1900 through 2004 an election year has historically been a good year in the stock market. Further supporting a strong stock market in election years according to the Stock Trader’s Almanac, the S&P 500 has risen in the final seven months in 13 of the past 15 presidential elections years since 1950. Plus, overall, the stock market is still at a discount compared to its all-time high. As of March 30, the S&P 500 is currently 11 percent under its all-time closing high of 1,565 on Oct. 9, 2007 (source BTN Research). We hope history repeats itself this year and the stock market keeps going up. We recommend two strategies to follow even when the market is good.
First, investors should remember to rebalance their accounts in all markets. Rebalancing is the process of selling investments that have outperformed and buying investments that have underperformed to reset the allocation of the overall portfolio back to the original plan. This is an important but hard to follow strategy of buying low and selling high. Stick with this disciplined investment approach, even when emotions say otherwise. The emotional battle the average equity investor may be having right now is: Why change when everything seems to be making money? One easy way to remove emotions and accomplish rebalancing in a portfolio is to set it up on an automatic change cycle, such as monthly, quarterly or yearly. This could help the average investor keep the plan on autopilot. Another option is to rebalance when the desired asset allocation changes beyond a set point. For example an investor who starts with 50 percent stocks and 50 percent bonds, may need to rebalance if stocks get more than 60 percent and bonds are now only 40 percent. This approach involves keeping a closer eye on the asset allocation of the plan to help determine when it’s time to rebalance.
Second, avoid chasing performance results. We have heard over the years people say “Things look better now so I’m ready to buy,” or, “Look how good that investment has done recently, shouldn’t I buy that?” That is a good question, but we suggest that you step back for a minute before buying any investment. Is that the right strategy? Ask yourself, have the individual investment goals changed? A conservative investor, who changes investments and gets much more aggressive after seeing results already go up, can dramatically increase risk. Instead of making major changes, consider making gradual changes. Although last year’s top performing investments could be winners again this year and next, remember that at other times the best performing investments of last year turn out to be the worst performing investments the following year. Prime examples are the technology stocks before and after 2000 and the financial and real estate stocks before and after 2008. Instead, try and focus more on long-term investing based upon your own individual goals and objectives, and less on other short-term results. Chasing results can be like being the last one to show up to a party, realizing too late the party is going to end.
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