Stock buys: Heed neither greed nor fear
The stock market has been on a roll, reaching new five-year highs and approaching all-time nominal (not inflation-adjusted) highs, which is tempting many investors to jump back into the fray. TrimTabs reports that investors have poured a record setting $55 billion into equity-related mutual and exchange-traded funds in the first four weeks of 2013, but is the optimism warranted?
There are a number of very good reasons for the rises in stocks. First, let's look abroad, where the outlook has improved. After two years of nonstop worry about the European "PIIGS" (Portugal, Ireland, Italy, Greece and Spain) and the debt crisis, the eurozone is no longer on the precipice of disaster. Additionally, when China's red-hot property market imploded, many worried that the Chinese government would not be able to manage an orderly cooling-off, its economy would come to a screeching halt and the miracle would come to end. That much-feared "hard economic landing" in China never came to fruition, and recent data suggest that the country is resuming a more consistent pace of growth. Finally, the election of a new government in Japan has been a shot in the arm for that country's multi-decade economic stagnation.
In this country, the congressional decision to delay the debt ceiling debate until May eased investors' concerns in the near term. There are other political and fiscal deadlines that loom, but none quite as severe as a potential U.S. default. Another bright spot is the housing market, which bottomed in 2012 and is starting to contribute to economic growth, rather than detract from it.
Perhaps the biggest boost to stocks has come from the Federal Reserve, which is likely to maintain its low interest-rate policies (including the monthly purchase of $85 billion worth of bonds) until the national unemployment rate drops to 6.5 percent.
Taken together, these factors have created a tail wind for stocks. But does that mean you should be more aggressive with your retirement assets? The answer is a resounding NO!
If you have been avoiding risk for the past few years, you have done so for a reason: You did not want to take the stock market roller coaster ride. Now that equities are up about 5 percent this year (not to mention that they've more than doubled since their low in March 2009), your inclination to dive back into stocks could just be because of the pesky voice of Greed whispering in your ear.
You might remember that guy, the one who persuades you that you are missing out on market booms after prices have already gone up. Greed is usually right about the market for a short time. Then, when the bottom falls out, his alter ego, Fear, shows up to convince you to sell everything. All of a sudden, your emotions ensnare you in a Greed-Fear tug-of-war in which you are buying high and selling low.
Compare that with a balanced approach that helps keep those emotions in check. Investors who create and adhere to long-term plans periodically rebalance their retirement accounts.
Here's an example of how it might work: Joe has been retired for five years and manages his investments by himself. Every few months, he checks his accounts to make sure that his 50-50 split between stocks and bonds remains in balance. When he last checked, his equity position had swelled to 55 percent because of the recent stock market rise. He diligently sells 5 percent of his stocks and rotates the proceeds into bonds. In other words, he forces himself to sell high and buy low, the exact opposite of what happens when Greed and Fear control his investment decisions.
The benefit of rebalancing is that instead of chasing stocks higher, you can be confident about selling as the market makes new highs and equally confident that you will buy when it drops to the lows.
Following a disciplined approach is never more important than when the market swings in either direction, and Greed and Fear come a-calling. Protect yourself and your assets by avoiding emotion-driven decision-making.
Jill Schlesinger is the editor at large for CBSMoneyWatch.com and writes this column for Tribune Media Services.