As of the close of yesterday’s trading day in the U.S, the public equity (stock) markets are up significantly since the start of the year; the S&P 500, by 18.76% and the NASDAQ 100 by a whopping 44.86%.
Is now the time to take some profits off the table?
How badly will you feel if you sell and those indices keep going up? How badly will you feel if you do not sell and those indices go down?
And how can one know when a market trend will stop and reverse itself?
When you open an account with a financial advisor you usually are required to fill out a form that is used to assess where on the spectrum you are in terms of being a defensive investor or an aggressive investor.
A defensive investor is more concerned with asset preservation and less concerned about earning the highest possible returns. An aggressive investor is willing to tolerate more risk to try to achieve higher returns.
I believe that this way of looking at investing is fundamentally flawed. Instead of trying to outperform a benchmark or adopt an overly aggressive or conservative investment strategy that may not align with your actual needs and circumstances, goals-based investing.
Goals-based investing links investing strategies to personal goals (like buying a home, financing a child’s education, or saving for retirement).[Editors’ Note: Watch Goal Based Investing — Planning for Key Life Events to learn more about goals-based investing]
Goals-based investing and asset allocation go hand-in-hand. Asset allocation refers to the way you divide your investment portfolio among different asset classes like stocks, bonds, cash, and various alternative assets (such as real estate, commodities, or private equity).
Don’t confuse asset allocation with diversification. Diversification happens at a ‘level down.’ For example, if you decide that 40% of your investment portfolio should be invested in the stock market, that is a decision about asset allocation. In contrast, the idea that you should not invest all 40% into a single stock implicates the concept of diversification.
You should (at least I do) seek both a proper allocation among assets classes and proper diversification within an asset class.[Editors’ Note: Read Investing Basics for Beginners Installment #3: Never Put All Your Eggs in One Basket for more information about allocation and diversification]
Your asset allocation should be in line with your financial goals and investment timeline. For example, a long-term goal like retirement planning may require a higher allocation to stocks or other growth-oriented investments early on, while a short-term goal such as saving for a car or a house might involve more conservative investments, like bonds or cash equivalents, to preserve capital.
When you identify and clearly define your goals, you can allocate your assets in a way that’s best designed to meet those goals. In case I’m not being clear, you likely do not have a single financial goal and, therefore, you likely should not have a single allocation strategy.
Your allocation among asset classes cannot remain constant. Assume, for example, a simple example in which you had $500,000 to invest and you allocated it as follows:
Let’s say some time has passed and your private equity investment is still worth $200,000, you still have $50,000 of cash (not actually cash, mind you; it would be invested in an FDIC-insured account earning interest), but the stocks did really well and are not worth $500,000 by themselves. That would mean your current asset allocation of your total portfolio, valued at $750,000, is:
Get it? Your stocks did so well that they now constitute an outsized portion of your total investment portfolio. Yet you originally determined that a proper allocation to stocks was only 50%. If your view on that question hasn’t changed, then you would need to sell some stocks, buy more private equity, and keep more in cash to bring your overall portfolio back into alignment with your original asset allocation.[Editors’ Note: Read An Initiation Into Private Equity Funds for information about this asset class]
Remember what I said about diversification within an asset class? Well, when you hear the name “S&P 500” or “NASDAQ 100,” you might reasonably assume that investing in those things (by buying index funds that invest in them. But you’d be wrong.)
The S&P 500 is composed of 500 of the largest (not necessarily the 500 largest) companies that trade on the New York Stock Exchange, Nasdaq, or the Chicago Board Options Exchange. As of May, however, the S&P 500’s five largest companies represented 22% of the index’s value.1 (Source: Yahoo Finance).
The NASDAQ 100 is even more concentrated: Just seven stocks (Alphabet, Amazon, Apple, NVIDIA, Meta, Microsoft, and Tesla) made up over 50% of its total weight of the NASDAQ 100 as of April.2 (Source: VisualCapitalist). So, even though the Nasdaq 100 is composed of 100 of the largest nonfinancial companies that trade on the exchange, they are not weighted equally (though, as widely reported, there will be a special rebalancing to address this issue that will take effect before the Market opens on Monday).[Editors’ Note: Read Investing Basics For Beginners Installment #1: What is Stock? And Should You Buy Some? for more information about investing in the stock market]
Trying to time the market is not what I’m talking about here.
“Timing the market” refers to the strategy of making buy or sell decisions by attempting to predict future market price movements. Financial Poise has written about trying to time the market in the past and its consistent position is that it is a fool’s errand. The strategy is also antithetical to strategies Financial Poise does advocate, such as a ‘buy and hold’ strategy and dollar-cost averaging.
You do you. Me? I don’t mind telling you that our financial advisor rebalances our portfolio regularly. And no, I don’t think it’s hypocritical or even ironic that I write articles like this yet use a financial advisor. We live in a world of specialization and when my financial advisor needs to negotiate legal agreements, he calls on a lawyer even though he is a former lawyer himself.[Editors’ Note: Read Choosing a Financial Planning Advisor: No Magic Involved for more information about how to select a financial advisor.]
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©2023. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.
Jonathan Friedland is a principal at Much Shelist. He is ranked AV® Preeminent™ by Martindale.com, has been repeatedly recognized as a “SuperLawyer”, by Leading Lawyers Magazine, is rated 10/10 by AVVO, and has received numerous other accolades. He has been profiled, interviewed, and/or quoted in publications such as Buyouts Magazine; Smart Business Magazine; The M&A…