Brendan McDermid/Reuters
I’ve been reading a lot about how overextended the stock market is, and that we should expect a major correction soon. Given that I have about 75 per cent of my registered retirement income fund in U.S. companies, should I consider selling some of those shares and moving the funds to a U.S. dollar high-interest savings account (HISA), at least until the correction happens and the dust settles? I know the “experts” say we should always stay in the market, because history has shown that it recovers after a big drop, but given that I’m 67, I’m not sure I can afford to lose half of the value of my portfolio and wait five years for it to recover. What’s your take? And how are you protecting your own investments?
Let’s be clear about something: nobody knows where the market is heading in the short run. I don’t know. You don’t know. The talking heads on CNBC don’t know. Even the market itself doesn’t know.
The only thing we know for sure is that, over the long run, the market has gone up. But in the short run – say the next few months or years – anything is possible. Could the market tumble 20 per cent? Yes, it could. Could it defy the skeptics and continue to “climb a wall of worry”? Yup. Is there any way to know in advance what it will do? No.
Now, back to your question. You asked whether you should sell some of your U.S. stocks and put your money into a HISA “until the correction happens and the dust settles.”
Here’s the problem with that approach. If the correction doesn’t happen right away, you could be sitting in cash and missing out on gains. If it does happen, you’ll feel like a genius – until you have to decide when it’s safe to jump back in.
It’s not as easy as it sounds. Many investors don’t have the stomach to buy when the economic and market indicators are flashing red. But if you wait until the “dust settles” – which I take to mean when the signals have turned positive – the next bull market will likely be well underway. In a worst case, you could end up buying back shares at higher prices than you sold them.
Why I’m buying more of these three dividend growth stocks
So what’s the solution? Rather than try to predict what the market will do in the short run, you should instead prepare your portfolio for a range of potential outcomes, taking into account your own risk tolerance, age and other sources of income.
In his 2009 book, The Investor’s Manifesto: Preparing for Prosperity, Armageddon and Everything in Between, author and financial theorist William Bernstein argues that investors need to determine their “equipoise point.” This involves choosing an allocation to stocks and fixed-income securities that will help to regulate your emotions and control your risk in any market scenario.
“Here is how it works: During a bull market you will derive pleasure from your stock gains and will regret that you were not more heavily invested; your equipoise point is that allocation at which this pleasure and regret exactly counterbalance each other,” Mr. Bernstein writes.
“Similarly, during substantial market declines, the equipoise point is that allocation where the pain of loss in stocks exactly counterbalances the warm, fuzzy feeling provided by your bonds and the capacity they provide to buy more stocks at low prices.”
In other words, your ideal asset mix is one that keeps you emotionally balanced through both gains and losses.
For some people, a classic 60-40 split of stocks and fixed-income securities (such as bonds or high-interest savings) does the trick, but you can dial the equity portion up or down to suit your own risk tolerance. Again, the goal is to position your portfolio so you’re partially protected in a downturn, but will also participate in any upside. This is fundamentally different from trying to guess the market’s direction, and in my experience it is the best way to deal with whatever the market throws at you.
Finding your equipoise point could also include tweaking the kinds of stocks you hold. You didn’t specify what U.S. companies you own, but many investors have gravitated to surging technology and AI stocks. These companies have produced outstanding returns but trade at high valuations, making them especially vulnerable to a pullback.
Gains in the tech sector have been so large that the so-called Magnificent Seven companies – Nvidia Corp. NVDA-Q, Microsoft Corp. MSFT-Q, Apple Inc. AAPL-Q, Amazon.com Inc. AMZN-Q, Meta Platforms Inc. META-Q, Alphabet Inc. GOOGL-Q and Tesla Inc. TSLA-Q – now account for roughly one-third of the S&P 500 index.
You asked what I am doing to control my risk. In my own portfolio, I balance my U.S. exposure (which I get with an S&P 500 index exchange-traded fund) with Canadian ETFs and dividend-paying companies such as utilities, banks, power producers and real estate investment trusts. These companies trade at less extreme price-to-earnings multiples, and the steady cash flow they provide is like a warm blanket when the stock market turns chilly. (For some examples, see my model Yield Hog Dividend Growth Portfolio.)
As for my personal asset allocation between stocks and fixed income, in my younger days I had about 90 per cent of my assets in equities, with 10 per cent in cash and high-interest savings. Now that I am in my early 60s, my equity exposure is closer to 75 per cent, with the balance in cash and HISAs. I also draw a company pension, and I’m eligible to start Canada Pension Plan benefits at any time. I can honestly say that, even though I hear the same warnings you do about stocks being overvalued and due for a tumble, I don’t spend a lot of time worrying about my investments.
Bottom line: It’s clear from your e-mail that you’re not comfortable with the level of risk in your portfolio. The solution isn’t to try to avoid the next drop. Rather, your goal as an investor is to structure your portfolio in a way that will give you peace of mind regardless of whether the market rises, falls or goes sideways.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.