5 things to do when stocks aren’t cheap
Joel Dresang: Marc, we see a lot about how stock valuations are above historical averages. What should investors be doing about that?
Marc Amateis: Well, I think first of all Joel, investors should understand that valuations have more to do with how much investors are willing to pay for earnings than it actually has to do with the price of a stock.
You know, in a low interest rate environment like we have right now with good earnings growth, investors are willing to pay more for stocks, and so that’s going to drive the valuations up. What it doesn’t mean is that investors should get scared out and bail on stocks or think that another crash is coming.
Joel: So, we can agree that, at least on a broad level, stocks aren’t cheap. How does that affect investment strategies?
Marc: Joel, it means that investors should have a well-balanced portfolio with a mix of assets. Might even want to add some asset classes that perhaps they haven’t been in recently, like Treasury Inflation-Protected Securities, which help if inflation starts heating up, or possibly even a small allocation to commodities.
And, higher valuations also will surely mean that the stock part of an investor’s portfolio has gone up relative to the other parts of the portfolio. So, you want to rebalance back to that level that you wanted to be at, at the first place.
For example, if an investor is targeting 60% in stock and the rise in the stock market has taken them up to 65% in stock, that’s a good time to rebalance. Get back down to the 60%. Take some money off the table, and protect your downside.
Joel: So, with higher valuations you’ve reduced some of the holdings in stock funds. What do you do with the proceeds?
Marc: Well Joel, really that depends on the individual, and it depends on the individual’s own risk tolerance and their needs going forward.
Joel: Well, what about somebody with a longer time horizon, so their tolerance for risk is greater?
Marc: Well, there we can do some additional rebalancing. Maybe we can look for some bargain, some undervalued areas that the investor hasn’t been in recently.
Emerging markets would be a real good example. You know, they lagged for many years and now they’ve been doing very well, so if the investor has the kind of time horizon and the ability to withstand the additional volatility, that might be an area of the market where we can put some money
But, investors also need to be careful, because cheap doesn’t necessarily mean it’s a good value.
Joel: So, how are you rebalancing portfolios for retirees?
Marc: Well, for retirees who are more concerned with income than anything else, one thing we try to do is have those people focus on the dividends from the stock part of their portfolio.
If their stock prices have gone down but their dividends are safe and providing the income that they need in retirement, focus on that. Don’t worry so much about the actual price of the stocks themselves. You’ve got time, prices will come back.
Joel: How are higher stock valuations affecting decisions made on money that’s supposed to be safer?
Marc: Well again, Joel, it depends on an investor’s risk tolerance, but some of the things that you can do is take some of those gains from the stock, build up an emergency fund, create a cushion for cash needs in retirement, maybe even pay off things like credit card loans or adjustable rate mortgages, where you’re paying a higher interest rate or the interest rate, you might expect, will go up with the rising interest rate environment. Those are things that you can do to lower your overall risk and benefit yourself in the long run.
Joel: What’s your biggest concern about higher stock valuations?
Marc: Joel, my biggest concern is that investors don’t blow it out of proportion. Valuations are just one aspect of an investment decision. Don’t try to time the market. Make sure you trust your plan.
Academic research clearly shows that the vast majority of an investor’s success comes from asset allocation and a properly balanced portfolio. It doesn’t come from trying to time the market or individual stock selection.
Valuing investments: Price-earnings ratio, a Money Talk Video with Dave Sandstrom
Rebalancing: More investing, less emotion, a Money Talk Video with Steve Giles
Investing for portfolio income as rates rise, a Money Talk Video with Kyle Tetting
Retirement 101: Having a plan, a Money Talk Video with Tom Pappenfus
(initially posted Feb. 20, 2017)