Despite the ongoing coronavirus pandemic and bear market of March 2020, equity markets have bounced back and hit new highs. While this is generally a good thing, extreme moves in any direction tend to test investors’ nerves and ability to adhere to a disciplined strategy.
These new market highs have exposed two different types of investor behaviors. The first behavior involves buying because of a market high. The second behavior is buying into a market high.
It’s important to determine which approach is better and what investors can learn from the latest market increase.
Investing Because of a Market High
Investors can become irrationally exuberant about recent market returns and pile into equities, often more aggressively than is appropriate for them. This is not a winning plan because it flies in the face of standard investing strategy – “buy low, sell high.” In fact, loading up on equities when markets have soared to new highs can result in “buying high, selling low” since emotion-based selling can often follow high-cost purchasing.
Investing because you have funds available is prudent, however, even if markets seem overvalued. One way to mitigate buying at the top is to average in, either through simple dollar-cost averaging, or via a less structured strategy that still takes advantage of investing over time.
The sooner you put your money to work, the faster it can benefit from compounding returns. Investing based on recent market euphoria should be avoided because it can lead to excessive risk-taking. Investors should also avoid investing in a portfolio that is based on short-term fear or greed instead of adopting a prudent long-term investing strategy.
In any type of market environment, investors must keep their emotions in check. Investing in equities because they have just hit new highs fails to take into account the investor’s financial situation or tolerance for risk.
Buying Into a Market High
Having a long-term investing plan and sticking to it can serve many investors well.
Investors who take this approach have a target asset allocation and realize that rebalancing is prudent when markets are either high or low. Rebalancing can address your portfolio when the target blend gets out of balance. This sometimes requires buying into markets when they are at a high. It is important not to let the market being at a new high stop you from being an investor.
Markets hit new highs all the time. If you think back to many points in the past, investing at those highs would be a dream scenario now. Imagine feeling frightened to invest in markets at previous highs – when the S&P 500 hit 1,500 in the year 2000, when it crossed 2,000 for the first time in 2014 or as it closes in on 4,000 in March 2021.
A savvy investor realizes the best time to be an investor is always now.
If you have a long time horizon for when you need the funds, short-term market movements are not that important. When wise investors have funds available for investment, they invest. It can be uncomfortable investing when markets are at a high. But there are various ways to mitigate the stress.
Find an Investing Strategy That Works for You
Implement a strategy where you average into markets over a period of time. You can select from a variety of averaging strategies such as simple dollar-cost averaging, value-based dollar-cost averaging, investing as you save into an account in a periodic way or an invest-by-numbers strategy where you have a program invest for you.
For example, if you invest a set dollar amount per month, investing at a high is less of a concern because you will have bought fewer shares at a higher price and more shares at a lower price.
Adding new funds or rebalancing into specific asset classes, sectors or segments that are available at a better price can remove some of the discomfort that comes when investing into new market highs. For example, if international stocks have lagged U.S. stocks for some time, you could consider adding a little more into international equities and less to U.S. stocks.
Work With a Financial Advisor
Working with a financial advisor who has designed a disciplined investment strategy for you can add value during turbulent times in the markets. When markets dip, a good advisor can help you stay the course and counsel you through rocky waters.
Your advisor should have a disciplined investment strategy for both buying and selling that proactively plans for your future needs and specific financial situation, instead of reacting or trying to predict short-term market events. In fact, working with an advisor can add about 3% in net returns to a portfolio, according to research from Vanguard.
Implementing a strategy helps remove a layer of emotion that can prohibit you from investing when markets hit new highs.
The most prudent thing you can do is to keep investing. Invest when you have funds available, including when markets are at new highs, into a low-cost, diversified portfolio that is designed for your financial needs and risk tolerance.
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Original source: U. S. News