You should never make investing decisions based on what the market is doing, except for now, maybe.
Past experience and reams of studies tell us there is no way to time the market and that we should buy and hold. That said, there are a few exceptions to the rule. With the total United States stock market up nearly 200 percent from the 2009 lows and increasing worries about what some pundits are calling “bubblelike valuations,” there are a few reasons you should think about selling now.
You got lucky. Did you buy an investment based on what you heard from your brother-in-law or a neighbor at a barbecue? Be honest! Sometimes, we trick ourselves into think that what we heard on CNBC was research instead of entertainment. Then, before we know it, we end up with some investment that’s exceeded just about every expectation. If you did nothing more than hear a tip from a friend or on the TV, that’s luck, not skill.
To use an extreme example people have been talking about lately, let’s say you placed a bet on Fannie Mae at the beginning of 2013. Remember Fannie Mae? It’s the poster child for the mortgage crisis along with Freddie Mac.
Both firms received huge amounts of cash from the government and were written off as dead by the market. In hindsight, it looks obvious: What a great opportunity! But if all you did was think, “Wow, that’s cheap,” with no research, well that’s luck. Lo and behold, Fannie Mae went from $0.30 to about $3. A ten-bagger, in market speak.
If you were lucky enough to buy Fannie Mae, now would be a good time to sell. To be clear, I’m not saying Fannie Mae will go up or down. I don’t know where it’s headed, but the point is, neither do you.
You got lucky, and it’s time to take your money and run.
You don’t know why you own something. Closely related to being lucky is the idea of being a collector of investments instead of an investor. If you don’t pay attention, you can end up with a portfolio suffering from multiple personalities where nothing works together particularly well. Maybe you inherited a bond from a grandparent or bought stock in a company where a friend used to work. Whatever the reasons, you now have a smorgasbord instead of a portfolio.
Chances are that smorgasbord has done well in the last year or two. That doesn’t make it a good portfolio.
Remember that almost every category of stocks has done well, so don’t confuse a rising market with your own personal genius. Now would be a good time to look at selling and using the money to build a portfolio on purpose.
You’re a systematic market timer. This sounds exciting! Like something those famous hedge fund managers claim to do. Before you get too excited, systematic market timing is the fancy way of saying you need to rebalance. If you already have a well-designed portfolio that you’ve built on purpose, what’s happening in the market may mean it’s time to sell.
For instance, your portfolio design may call for 60 percent stocks and 40 percent bonds. But since stocks have done really well in the last year, your portfolio may now be 70 percent stocks, even with the recent decline. So, in that case, you should be selling stocks and buying bonds to get you back to your 60/40 split.
The one caveat I’ll add is that rebalancing is not a daily or even weekly activity. So don’t get carried away. Systematic means just that. It’s selling based on specific criteria and not whenever the mood strikes, and it is going to be dependent on what’s happening in the market. An added benefit? Changing the way you think about boring rebalancing means the next time the cocktail conversation turns to making smart moves in the market, you can proudly proclaim that you’re a systematic market timer.
One caveat here: If you’re thinking about selling now, there’s a big difference between selling out of fear and selling by design. We want to take action based on a principle — like being diversified in the case of a big holding in an individual stock like Fannie Mae — instead of emotion. Otherwise you may find yourself in the awkward position described by Warren Buffett.
While he recognized that a rising tide — or market — covers a multitude of sins, you only find out who is swimming naked when the tide goes out. I’m betting we’d all prefer to be wearing our suits. So if you’re thinking about selling now, make sure it’s for a legitimate reason, not an emotional one.
This commentary appeared February 10 on NYTimes.com.
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