A retiree called me, nervous about the stock market crashing. He wanted to know if he should abandon the markets by selling his stocks and staying in cash.
An alternative to timing the market
Since you can’t predict when the market will crash, you need a good defense. Historically, selling out has rarely been a winning, long-term strategy, since it’s hard to know when to go back in. It’s prudent, though, to diversify beyond stocks into fixed-income (bonds), cash, and other less risky assets.
Allocating more of your portfolio to safer asset classes like bonds and bank deposits may seem counter-intuitive when interest rates are low. In fact, when the stock market is going up, investors sometimes borrow money to buy more stocks. With interest rates at historic lows, investors can access cheap money and invest more in today’s stock market. But this kind of leverage is usually too risky for most people.
Is this stock too expensive?
When investing, ask yourself, “Am I paying too much for this stock?” Nobel Prize winner (and former guest on The Goldstein On Gelt Show) Robert Shiller developed a market indicator to answer this question. The Shiller P/E ratio tells you how much in earnings each of your dollars buys (stock price divided by average (moving average) 10-year earnings, adjusted for inflation) when applied to an individual stock, sector, or market. From 1890 to present, the average Shiller P/E for the S&P 500 was 16. The ratio spiked before the 1929 Wall Street and 2000 dot-com crashes. The current Schiller ratio is 29.85 – the highest since the 2000 market downturn, when it hit 45. Some investors believe the best is yet to come, but others feel the opposite.
The retiree who called me fearful about the rising stock market needs to know that no one can time the market. Instead, folks should review and rebalance their portfolios based on their needs and their tolerance for risk.
For more on how to diversify your portfolio to decrease risk and produce more consistent performance, click here.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published December 18, 2017.