How to Play the Market's Continued Success

Typical investors have been doing two things since the market dropped by more than 50% by February 2009. Either they stayed in the market despite their losses and have seen a significant gain in their portfolios or they got out of the market when it dropped and they have been sitting on the sidelines, frightened to risk any of their hard-earned assets to an unpredictable market.

The latter group has seen the market appreciate without benefiting from the appreciation. But now that the market is hitting new highs, both groups of investors must decide how to continue from here.

If you benefited from market appreciation

This group needs to avoid the temptation of greed often heard as “It’s gone this far I wonder how much higher it can go if I don’t sell it?”

When a stock in your portfolio has experienced significant gains, one is almost always tempted to see how great the gains might be if you do not sell or rebalance. The stock, as well as the market, may be at its all-time high. It’s a risky decision to do “business as usual” and not make changes to your portfolio when the market reaches new highs.

Instead now is the time to rebalance your portfolio, take some gains and then reinvest those gains in a different market sector to protect yourself against a stock that suddenly goes out of favor.

Tip: To reduce or eliminate taxable gains, sell positions with gains in your deferred retirement accounts first.

If you missed the market appreciation

The investors who sat on their hands for far too long, and missed the market appreciation, need to ask themselves how much longer they can afford to sit on the sidelines. Many financial advisors will say you need to get into the market, but in a methodical way.

For example, you should decide what percent of your portfolio you want to invest in fixed income (i.e., bonds), which reduce the risk of a portfolio and thus add stability, and what percent of your portfolio you want to invest in stocks or equities for growth.

A key concern after a market run up is whether now you will be paying a premium to invest in the stock market. To minimize this risk use a dollar cost average approach, investing a specific amount in phases at specific intervals. For example, if you currently have 100% in cash and decide you ultimately want to have 50% of your portfolio in the stock market, make equal monthly investments over the next 12 months, using the cash to purchase 50% fixed income and 50% equities. Most likely some of your purchases will be made when the market is higher (and the shares will cost more) but other purchases will be made when the market is lower. Thus, your ultimate cost will be based on the average of your purchases.

Also, instead of individual bonds or stocks, invest in low-cost mutual funds. For example, if you purchase a mutual fund that tracks the S&P Index, you will be investing in 500 of the largest companies in the U.S. So while you are getting back into the stock market, mutual funds enable you to make small purchases but diversify your risks and opportunities across numerous companies as opposed to one.

Barry Taylor, CFP, Integral Financial Solutions, LLC, San Francisco, can be reached at [email protected].