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With the markets pushing record highs, how should you react?


Sticking to your investment strategy can help avoid emotion-driven decisions.

Jeff Witz, CFP

Jeff Witz, CFP

The markets seem to be pushing record highs. Are there adjustments I should be making to my portfolio?

As the COVID-19 vaccine rollout continues and another stimulus package has been approved, the equity markets have again pushed against all-time highs. These moments tend to elicit 2 very different responses from investors: euphoria and fear. Some investors view this as a sign to get more money in the market and hope the wave continues moving upward. Others see this as a sign that we are due for a pullback and start taking money off the table. Both of these actions are emotional responses. Investing with emotion is a risky endeavor and can lead to costly mistakes.

Removing emotion when investing is never easy. However, successful investing requires exactly this level of discipline. What can you can do during these moments when markets are pushing highs and there is uncertainty about their future direction?

Have an investment strategy and stick to it. Every investor should have an investment strategy printed out and pinned to their desk. An investment strategy keeps you disciplined. It will tell you when to buy, what types of investments to buy, and when it is acceptable to sell. An investment strategy allows you to block out the noise in the markets and media and focus on growing your wealth in a disciplined way.

Rebalance. Often when markets are performing well, there are specific asset classes that drive that performance. This often leads to these categories becoming overweight compared with their target percentages because they have grown significantly. If this is true for your portfolio, now may be a good time to rebalance. Keeping your asset allocation in line with its target percentages is key to long-term investing. If your equity categories are overweight, the risk in your overall portfolio has increased, since these tend to be the most volatile asset classes.

There are 2 ways to rebalance. You can sell the category that is overweight and reallocate the proceeds to underweight categories such as bonds and real estate. This will add more downside protection in the event markets turn negative. However, the tax implications of selling must be considered. Rebalancing in tax-advantaged accounts such as 401(k)s and IRAs is easy to do; you can sell investments without having to worry about capital gains taxes. That is not the case with taxable accounts such as individual, joint, and trust accounts. Selling an investment with a significant gain in these accounts may result in owing a hefty capital gains tax. For these types of accounts, the second rebalancing strategy typically works best: add more money to the account and apply that money to the underweight categories.

Stockpile cash to invest if the market experiences a correction. The markets will experience a correction. Knowing exactly when is impossible without a crystal ball. However, corrections provide excellent buying opportunities, as some investments may be trading at a discount. By having cash on hand, you can be prepared for when that moment comes.

Determine what amount you feel comfortable with having in reserves and eventually investing. When a market correction occurs, use this stockpile to invest in categories trading at a discount. You do not typically want to invest your entire cash reserve at once. If the markets continue to move downward, you will have gone all in before the investment hit bottom. To avoid this risk, use a dollar-cost averaging strategy to invest incrementally over a set period of time. Buying incrementally as investments go down will allow you to get in at good prices, but removes the risk of going all in at the wrong time.

When markets are pushing highs, everyone wants to know if they will keep going or if they are due for a pullback. No one can know for sure. The best thing you can do is have a plan in place so you know how to react regardless of which direction the markets go, remain well allocated and diversified across asset classes, and have cash available in case a buying opportunity arises.

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Effective June 21, 2005, newly issued Internal Revenue Service regulations require that certain types of written advice include a disclaimer. To the extent the preceding message contains written advice relating to a Federal tax issue, the written advice is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer, for the purposes of avoiding Federal tax penalties, and was not written to support the promotion or marketing of the transaction or matters discussed herein.

The information contained in this report is for informational purposes only. Any calculations have been made using techniques we consider reliable but are not guaranteed. Please contact your tax advisor to review this information and to consult with them regarding any questions you may have with respect to this communication.

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