I spoke to Fran Kinniry, principal in Vanguard’s investment strategy group. “I always tell people to be consistent in their thinking,” he said. “People think they are O.K. with their portfolios now, and why not? They’re probably sitting on big gains.
“But then I ask, imagine that you have a $1 million portfolio and you lose 30 percent, because that can happen, and that’s $300,000. Now you’ve got just $700,000. How do you feel now? Would you be willing to stay in the stock market — and even sell some bonds, which have held on to their value, and use the money to buy more stocks, which are relatively cheap now? If the answer is no, it’s important to know that now and to act on it.”
If you realize that you can’t afford to risk any losses, he said, you shouldn’t be investing in stocks at all and this is a great time to sell. It’s as simple as that.
That said, there is no reason to conclude that a big stock market decline is starting tomorrow. That might happen, but stocks may well rise for quite a while. Some astute analysts, like Laszlo Birinyi, an independent stock analyst in Westport, Conn., believe they probably will.
“We are in a bull market,” he declared in an email, adding that there are plenty of opportunities in individual stocks which continue to gyrate, even if the overall market is surprisingly stable. Valuation concerns and technical indicators like market breadth and investor sentiment are worth considering, he said, but “none of them end up with a SELL” signal for the entire market. Mr. Birinyi says there is still money to be made by buying stocks. He may be right.
Still, after so many years of gains, there are hidden dangers.
Many investors are suffering from portfolio drift. As Mr. Kinniry of Vanguard says, even if your long-term strategy is well thought out, the colossal gains in the stock market could mean that you hold far more stock than you ever intended. In that case, you have taken on unintended risk because your portfolio has drifted far from its original moorings.
“If you have not looked at your portfolio for a long time,” Mr. Kinniry said, “the chances are very high that you should rebalance.”
Rebalancing implies returning to the mix of assets that is appropriate for you. What that mix should be is a personal question. Major mutual fund and brokerage companies and individual financial advisers offer counsel. And there are standard guidelines, though no one-size-fits all solutions. The financial quizzes I’ve taken all suggest that my holdings should be 60 to 70 percent stock, offset by 30 to 40 percent bonds, and I have remained within those parameters for 20 years. I’m closer to 70 percent stocks right now. I probably should rebalance.
In an email, William J. Bernstein, an independent investment adviser and author, put the challenge of investing this way: “Job one is to figure out your overall split between stocks and fixed income, and then what percent of stocks are domestic and foreign. Job two is to make absolutely sure that you don’t overestimate how well you’ll respond to a real market decline, particularly after a several-year period of high stock returns. How well you adhere to your allocation is more important than what that exact allocation is.”
Why hold stocks at all? It is because over periods of 20 years or more, stocks have almost always outperformed bonds, although stocks swing more wildly. That’s why it is generally thought that people with a long horizon should hold a bigger proportion of stocks than those who are living off their investments, or will soon do so.
But behavioral considerations matter, too. The classic advice for long-term buy-and-hold investing assumes that you will be emotionally capable of sticking with your holdings for the long term, and not panic and sell inopportunely when the market falls. In real-world downturns, however, many people desperately want to sell stocks, or suddenly realize that they must sell, because they need the cash. That’s why the steadier performance of bonds can be a source of great comfort.
“Rebalancing is more a risk-control measure than a return-generator,” said Dougal Williams, an independent financial adviser.
The problem, however, is that maintaining the right mix takes work. Someone else can do it for you, or you can do it yourself. If you have been letting things slide, it is time to rebalance.
Consider what would have happened if you were fortunate enough to hold a $1 million portfolio at the end of 2008, containing 60 percent stock and 40 percent bonds (a 60-40 portfolio). Recall that the United States stock market fell a whopping 37 percent in 2008. Holding as much as 60 percent stock after that debacle required some fortitude, along with a belief that the stock market would eventually rise. And it did. But look at what the market has also done:
That’s why it may be time to take some money off the table, even if, by doing so, you will be giving up some of the gains that will come when the stock market rises.
“Be capable of sticking with your strategy in the best of times and the worst of times,” Mr. Kinniry said. “It’s much easier to think clearly now than in the middle of a big market downturn.”