Reacting to a Stock Market Increase

by Michael on Jan 8, 2014 · 2 comments

Image of a Man Drawing a Stock Market Graph

A reader named Jorio recently wrote in to ask:

The stock market has skyrocketed. How can I harvest some of the gains and protect them from a “bubble burst”?

Indeed, 2013 saw a huge runup in the stock market, with the S&P 500 rising nearly 30% and the Dow increasing 26.5%. But does that mean that we’re in the midst of a bubble that will ultimately burst?

Maybe. But maybe not.

And therein lies the problem. I don’t have a crystal ball so it’s impossible for me (or anyone else) to predict what will happen in the future. This is particularly true when it comes to predictions regarding the near-term future.

If we look farther out, say 10-20 (or more) years down the road, I’m fairly confident that the stock market will be at considerably higher levels than it is today. But next week? Next month? Next year? That’s anybody’s guess.

So when I’m asked how to react to a market increase, my answer is to check your portfolio. Is it still in line with your target allocation? If so, then it’s probably best to do nothing. If not, then it’s probably time to rebalance.

Related: If you’re looking for a handy way to keep track of your portfolio, check out Personal Capital. It’s free, and provides you with a slick online dashboard for tracking all aspects of your financial life. Here’s my review.

While rebalancing will likely have the effect of “locking in” some of your gains, that’s not really the point. Rather, the point of rebalancing is to avoid portfolio drift, thereby maintaining your desired risk profile.

Said another way, if recent market performance has resulted in a stock-heavy portfolio, you’re taking on more risk than intended. It’s thus probably best to pare that back to your original target.

If you’re still tempted to tweak things in response to recent market performance, you might want to take a quick look at the following graph from Bob Doll of Nuveen Asset Management (click to enlarge).

Graph of Investor Performance

Yes, aggregate analyses of this sort have their shortcomings, but still… I think it’s safe to say that, on average, individual investors aren’t consistently making market-beating (or even market-matching) decisions.

In my view, it’s thus best to minimize the human element when investing. Target a well-defined asset allocation and maintain it with specific rebalancing rules. If you don’t, you may wind up making knee-jerk decisions that you’ll live to regret.

1 krantcents January 9, 2014 at 11:09 am

Investing long term requires a plan (asset allocation) and to stick with your plan based on your desires and risk tolerance. Reviewing it annually is a good way to monitor your plan.

2 Kurt @ Money Counselor January 9, 2014 at 12:02 pm

I’m fascinated by this topic. Virtually everyone who pays attention and has learned about investing knows intellectually that individuals–including fund management–cannot consistently time the market to their advantage. Yet virtually everyone tries to do it, evidently thinking that they’re smarter than “average.” You can’t watch CNBC for 5 minutes without seeing a discussion of whether it’s time to “get in” or “get out”. What a bunch of malarkey.

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