As the market flirts with all-time highs, what can investors do to stay disciplined?
The stock market continues to reach new all-time highs even as it adjusts to new expectations regarding the Fed (The Federal Reserve) and economic expansion. As growth accelerates and corporate profits beat estimates, some investors may be enthusiastic about this momentum while others may be worried that stock prices have run too far too fast. How can all investors stay disciplined in this environment?
Market prices and daily returns don’t tell the whole story
One source of investor concern arises from focusing too much on market prices and daily returns. While this information is easily accessible and widely reported, it does not tell the whole story. First, the fact that the stock market has risen does not guarantee it will crash in the near future. The recent pullback in response to the Fed only saw the S&P 500 decline 2.1% before rebounding.
Chart: The S&P 500 is hovering near all-time highs
Sources: Clearnomics, Standard & Poor’s
In times like these, it’s wise to consider maintaining a balanced portfolio
Some may also find it surprising that there have been 30 new record highs achieved this year. This is because, by definition, the stock market spends most of its time at or near all-time highs as it rises during bull markets. There have been many periods when the market seemed to defy gravity for months or years, including during the decade after the 2008 financial crisis. Rather than try to avoid short-term market pullbacks, it’s much more important to hold balanced portfolios that can withstand these stumbles.
Two ways a balanced portfolio can help the long-term investor right now
- A balanced portfolio can help manage risk. The reason investors have the opportunity to be rewarded over time is because they are willing to assume a certain amount of risk, especially when it is least expected. However, it’s also the case that missing potential upside is just as harmful to achieving long-term financial goals. Case in point: those who stayed on the sidelines after the initial pandemic market crash last year have missed out on the strongest recovery in history.
- A balanced portfolio can help offer opportunities for gains. Second, what truly matters to investors isn’t what it costs to buy a share of stock, but what they get for that price. Stocks are one of the foundations of any portfolio because they provide investors with a “share” of corporate profits which tend to grow over time. Financial ratios such as price-to-earnings may matter much more to investors since they show what it costs to buy a dollar of earnings.
Market ups and downs are to be expected
At this stage in the recovery, corporate earnings have returned to pre-pandemic levels at least two quarters faster than consensus forecasts originally suggested. Consensus estimates today suggest that earnings could continue to accelerate into 2022 as demand heats up, fiscal policy stimulates the economy and monetary policy keeps financial conditions loose. All of this means the economy looks to be bouncing back sooner and stronger than expected, though this can change based on factors like the ones mentioned earlier.
The stock market is forward-looking and incorporates new information quickly. Even if the market isn’t perfectly “efficient,” it is difficult to consistently guess what it will do next. Holding a portfolio that is built to balance risk and return appropriately — even when the market appears to be at a summit — is a good way to plan to achieve financial goals.
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