Money Matters: Smart investing when markets approach record highs

Jeff Witz, CFP

The equity markets have been on a roller coaster ride in 2024. Hot out the gate to start the year, followed by a sharp pullback when inflation numbers temporarily stopped their decline, and now back to hovering near record highs. Investor euphoria, and conversely concern, is rapidly growing due to the US stock market’s rise to all-time highs. Investors are asking how high is too high and how long it will last. Nobody knows for certain, but we can expect continued volatility if the bull market matures. Be prepared. By their very nature, financial markets rise and fall constantly, with an ever-present potential for gain or loss. During periods of new highs, financial markets often see wide swings in market value. The key is to have a plan in place well in advance of large market sell-offs or increases.

First, it is vital that during these periods, investors 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 turns paper losses into real ones and limits any possible gains should the market recover. These same investors often buy when the markets are “hot” and values are rising.

In these scenarios, the investor buys high and sells low, which is the opposite of the fundamental investment premise of buying low and selling high. These acts are emotional reactions to what is occurring in the markets and can lead to significant investment loss or underperformance. Another way of saying this is that the greatest threat to your long-term investment success can be you and your emotional reaction to what is happening in the markets. You need to have a formal investment plan to protect you from yourself.

A critical piece of this plan is your asset allocation. Study findings show that asset class selection and the percentage invested in these various asset classes are key determinants of long-term investment success. Asset allocation modeling is an investment strategy that seeks to reduce investment risk by spreading an investor’s portfolio over several different asset types and classes. This diversified approach takes advantage of the tendency of various asset types to move in different manners and cycles to smooth out the ups and downs of the entire portfolio. Equities, bonds, and cash (or cash equivalents) are the broad asset classes typically used. Investors can also include tangible assets such as real estate for further diversification. An allocation should be determined well before any market hot or cold streaks.

If an investor has an asset allocation strategy in place and is well disciplined about sticking to that allocation, they can ignore much of the outside noise. They don’t have to be concerned about reacting to changes in the market—they understand that this is the natural ebb and flow. Although US markets are performing well now, that is unlikely to continue forever. When the US markets do experience a correction, an investor’s holdings in international markets, bonds, or real estate will be there to smooth out the blow caused by downward movements in domestic equities.

During near record-high markets, it is also essential for investors to plan how they will approach buying and selling securities. Rather than making a single lump-sum investment during new market highs, some investors feel more comfortable investing an equal dollar amount at regular intervals. This process is called “dollar-cost averaging” and enables you to buy more shares when the price is lower and fewer higher-priced shares as the market climbs. You can use this same approach when selling holdings. Keep in mind that dollar-cost averaging does not assure a profit and does not protect against losses in a declining market.

Finally, adjusting the asset allocation by rebalancing on a quarterly basis is a regular part of sound investment management in both up and down markets. These adjustments are scheduled and planned, not reactionary. The purpose of rebalancing is to realign the portfolio back to the intended percentages assigned to each investment and asset class. Staying close to your desired asset classes can produce a smoother investment experience.

As the markets continue to push record highs, staying disciplined in your investment strategy, removing emotion from your decision-making, and sticking to an appropriate investment allocation will be vital to navigating market swings.

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