Stocks Keep Rising, Should You Worry?

Posted on August 1, 2014 at 8:45 AM PST by

Remember riding waves at the beach as a kid? The water seemed so powerful, and every swell that pitched up offshore was “the big one,” the wave that was going to carry you all the way to the sand in a glorious, foamy ride.

That’s what the stock market feels like these days, especially if you pay attention to financial media pundits. Every day a new high, a new swell of rising stock prices. And the pundits all jump up and yell, “That’s the one! That’s the top of the market! Sell!”

They’ll be right someday. Meanwhile, the pundits have nothing to lose calling every new market high as the obvious “big one,” the moment when you should have sold it all and got ready to ride to shore.

stocks

Yet day after day the swells just pass on by, coming to nothing. You have to wonder if any of the crash-minded talking heads took their own advice and sold all their stock months ago. Surely the market top they saw at the beginning of the year is identical to the one they saw this week and to the one they see coming next week and the week after.

Every swell looks the same, until one finally forms a wave and crashes into shore. By the time you see this article, it may have happened. But read on.

If you ask any smart investor if the market will decline, the reasonable answer is “yes.” The question you really need to ask, however, is when will it decline. The reasonable answer there is, “I don’t know.”

Assuming you fall into the reasonable camp, the question then becomes: What will happen to my investments if one of those swells rears up and takes down the market with it?

At the risk of sounding a bit boring, professional pension managers do not worry about this kind of issue at all. That’s because they’ve already measured out their liabilities into the future and invested accordingly. For them, falling prices are as much as an opportunity as they are an obstacle.

What does that mean for ordinary savers? In the simplest terms, it means you should own a balanced portfolio of stocks, bonds and other assets, such as real estate, one that is matched to your ability to assume risk.

If you are young, say in your 20s or early 30s, a portfolio that is heavy on stocks is actually a great thing. It might decline in face value from time to time, perhaps dramatically once or twice in your life, but that’s okay. Lower prices mean you can buy more shares, more cheaply. Just keep saving and investing.

Stocks generate cash

If you are very near to retirement, however, a portfolio full of equities is ticking money time bomb. It’s highly likely that a big market decline will hurt you. The number of years you have to recover and rebuild are limited.

Somewhere in the middle? Split it up. Own perhaps a bit more stocks than bonds and rebalance religiously. That way, a rising stock market becomes a way to generate constant cash to be reinvested in other asset classes. If you keep your stock allocation fixed by rebalancing, your exposure is thus naturally limited.

It’s not rocket science, it’s passive investing that works. It also takes a load off your mind, a welcome change if you’ve been spending the last few months glued to financial TV, waiting for a wipeout.

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