Stock market reaches new heights; is it time to sell?

July 22, 2014

By their very nature, financial markets rise and fall constantly, with an ever-present potential for gain or loss. The key is to have a plan in place in advance of large market selloffs or large market increases.

The stock market has hit new highs this year. Is it time to get out?

Investor euphoria-and conversely, concern-is now growing due to the U.S. stock market’s rise to all-time highs. How high is high, and how long will it last? Nobody knows for certain, but we can expect continued volatility if the bull market continues to mature. Be prepared.

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During periods of new highs, financial markets are often exposed to wide swings in market value. Such market volatility, with prices sharply rising and falling, is a reflection of changeable investor sentiment as well as possibly more substantive economic or political events. By their very nature, financial markets rise and fall constantly, with an ever-present potential for gain or loss. The key is to have a plan in place in advance of large market selloffs or large market increases.

It is important during these periods for investors to avoid emotional responses to investing. If markets fall sharply, some investors will sell all or part of their holdings and shift into what they perceive to be “safer” investments. Such emotion-based selling after a market decline simply turns paper losses into real ones and limits any possible gains should the market recover. These same investors will also respond emotionally and buy when the markets are “hot” and values are rising. The result is frequently an investor who buys high and sells low and consistently loses money.

Other investors attempt to time the markets: selling when the market is thought to be high and then buying when the market is considered to be low. The problem is that it’s never clear just when the market has reached a trough or a peak. Market timing is a concept that, in theory at least, seems logical. In practice, however, no one has yet devised a system for consistently and accurately identifying market tops and bottoms. Many have sold prior to the market moving lower, but just can’t find the low point to buy back in, and often buy after prices have risen, just like the emotion-based investor.

 

Next: Asset allocation modeling

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There are, however, ways for investors to cope with fluctuations in the market. Asset allocation modeling is an investment strategy that seeks to reduce investment risk by spreading an investor’s portfolio over a number of different asset types or classes. This diversified approach takes advantage of the tendency of different asset types to move in different manners and cycles in an effort to smooth out the ups and downs of the entire portfolio. Stocks, bonds, and cash (or cash equivalents) are the broad asset classes typically used. Tangible assets, such as real estate or gold, may also be included for further diversification.

The asset allocation process begins with an analysis of the historical levels of risk and return for each asset type being considered. These historical values are then used as a guide to structuring a portfolio that matches the investor’s individual goals and overall risk tolerance level. It’s crucial that an investor’s portfolio allocation reflects factors such as their investment goal, time frame, need for liquidity, risk tolerance, and income tax bracket. As time passes, and as market and economic conditions change, it is likely that an investor’s goals, and the optimal portfolio mix to reach those goals, will also change. Adjusting the asset allocation by rebalancing on a quarterly basis is a regular part of good investment management in both up and down markets.

Market volatility also impacts the implementation of a new investment strategy. Rather than making a single, lump-sum investment during periods of new market highs, some investors feel more comfortable investing an equal dollar amount at regular time intervals. This process is referred to as “dollar cost averaging” and enables you, as the market climbs, to buy more shares when the price is lower and fewer shares when the price is higher.

Keep in mind that dollar cost averaging does not assure a profit and does not protect against losses in a declining market. Investors should therefore consider their financial as well as emotional ability to continue purchases through periods of low price levels.

 

What is the preferred method to move funds from one individual retirement account to another?

The Internal Revenue Service recently announced that individuals will be permitted only one IRA-to-IRA rollover per a 12-month period, with enforcement becoming effective Jan. 1, 2015. In this arrangement, an individual receives a distribution check from one of their IRAs and has 60 days to deposit the same amount into an IRA in order to avoid the distribution being treated as taxable income. This newly imposed limit fortunately does not apply to trustee-to-trustee transfers. There continues to be no limit on the number of transfers directly from one IRA to another, which is the generally recommended manner in which to move funds from one IRA to another.UT

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