With major stock market indices soaring higher and higher, investors and pundits increasingly express fear that a horrible economic collapse is imminent. Predictions of the world coming to an end soon have brought society to a financial panic that can be avoided.
In 2007, devastation traumatized investors as the financial markets and economy faltered. Followed by a terrible collapse and panic of the markets in 2008, recovery soon ensued: by early 2018 the Dow Jones Industrial Average reached 3.5 times its 2008 low of less than 7,500.
What should investors do in the face of a potential bubble? The answer is simple: make calm, conservative adjustments.
Many investors are searching for a seer who can help them time in and out of the market just before the next collapse or rally occurs. Unfortunately, major portfolio shifts designed to time markets will likely fail in the long run.
The real issue here is not fear –it’s greed. Most investors are not necessarily fearful that the market will collapse and never come back, but are seeking to time the markets and profit from selling at the top and buying at the bottom.
So, should investors do nothing? Perhaps. Or perhaps rebalancing back to target risk exposures is in order.
The level of risk in an investor’s portfolio should be driven by their financial circumstances and tolerances for risk, not by efforts to time financial markets.
Consider an investor who a few years ago determined that a 60% stock – 40% bond mix was appropriate. When the stock market doubles and bonds gain by 25% that portfolio mix will automatically drift to 70% stock and 30% bonds. Rebalancing of that portfolio back to a 60/40 mix may be appropriate. Conversely, after a stock market collapse it may be a good time to rebalance from bonds to stocks to bring a portfolio back in line with the investors long-term risk preferences.
Rebalancing tends to work poorly in the long run in markets that trend and work well in markets that tend to return toward historic levels. Historical evidence indicates that financial markets tend to trend over moderate periods of time such as months or a few years.
Markets have tended to revert towards more normal levels over periods of several years. So, investors should consider rebalancing every so often – depending mostly on the size of the market movements that have occurred and the extent to which the portfolio’s risk level has departed from its target.
Maintaining a healthy and well-balanced attitude will keep your priorities in check. While there will always be those who predict an apocalyptic collapse, such supposed experts in market-timing are much like the gurus of the past who have convinced cults that the end of the world is imminent. You may even receive a call convincing you to sell all financial assets and buy precious metal; don’t drink that Kool-Aid.