How do you keep a cool head in a market that's hot hot hot?
That's the question I posed to Morningstar.com readers in a Discuss forum conversation this past week. After all, investors often make their biggest mistakes at inflection points--either when the market is peaking or troughing. How, I wondered, had seasoned investors or savvy newbies learned not to get caught up in the euphoria and instead make decisions they would not regret at a later time?
Readers complied by sharing a host of behavior-management techniques, many of which fit in all types of market environments, not just strong ones. To read the complete thread or share your own tips for ensuring that your own worst instincts don't take over when the going gets good, click here (http://socialize.morningstar.com/NewSocialize/forums/p/333359/3495732.aspx#3495732). I shared some of my own thoughts in this video (http://www.morningstar.com/cover/videocenter.aspx?id=620785).
'Take a Vacation So That You Don't Tinker So Much'
Tuning out the day-to-day noise and maintaining a dedication to a simple portfolio plan--rather than one that's cluttered up with lots of specialty items--were at the top of ColonelDan's list. "I've tried to learn from my younger days when I allowed the market to dictate my actions," this veteran poster wrote. "I now make moves based on my personal situation, keeping my approach simple and my focus on the long term. Translation: I'll make no moves based on today's market highs that in years to come will be seen as just normal market behavior."
Similarly focused on the long term is another investing (and military) vet, Taylor Larimore. This Boglehead wrote, "When I started investing in 1950 the S&P 500 was less than 20. Today it's more than 1,700 (not including dividends). I'll continue to follow Jack Bogle's advice: 'Stay the course.'"
To do so, posters advised, it's often best to back away from that portfolio rather than succumbing to the urge to make changes.
Juris2 noted, "This is the type of market and the time of year when I am most tempted to tinker. Perhaps one recommendation: Take a vacation so that you don't tinker too much."
Chief K said he purposefully takes a deliberate approach to making any portfolio changes to avoid rash decisions; his process encompasses a top-to-bottom financial review and plays out over several months. "The time delay is to ensure that I have ample opportunity to review my decisions," the Chief wrote. "It's hard to 'Stay the Course' if you find yourself changing your mind about where you are going."
ForrestGump agreed that having a well-articulated process is essential to not get swept up in market manias. "Have a plan or set of investment guidelines and stick to it. It takes emotion out of the equation and turns the process into something mechanical."
Amhorst, an early accumulator, wisely argues that a dollar-cost averaging program is one of the best ways to stay disciplined even though it's hard not to check that balance. "I check my accounts most days because I'm behind my computer a lot for work, but have no intent of changing our plans based on fluctuations. My wife and I are 26 and our investments are all in a Roth 401(k) and Roth IRAs and we're trying to fill them up as much as possible, dollar-cost averaging into an aggressive 90/10 AA, which we'll reassess time to time based on retirement horizon."
'That Is Where I Steer Money, Even If I Have to Hold My Nose'
For many posters in the thread, rebalancing is one of the smartest ways to ensure discipline and safeguard against getting caught up in market froth. Scaling back on whatever has been rallying may hurt near-term returns if momentum continues, but rebalancing is one of the best ways to reduce a portfolio's risk level.
DBSMichigan noted that rebalancing is a lot easier to pull off than market-timing. "Timing the market by moving between cash and equities is a fool's game because you would have to be more or less exactly right twice in a row. I learned this in 1987, when I completely sold out of the equity market at the end of September. Thought I was a genius for a few months. However, by the time I bought back in (end of March 1988) the indexes had already recovered to above where I sold out. I instead practice risk management in rebalancing my portfolio."
With retirement fast approaching, Mwmckay believes that scaling back on equities is important. "As someone who will retire within the next few months, I am definitely concerned about a potential market decline. Thus, I am reducing my equity/alternatives stake from 55% to 35%-40%. To avoid panicking at the wrong time, I have been reducing my equity/alternatives stake by 1% each week beginning about six weeks ago. This seems like dollar-cost averaging for selling rather than buying. Yes, I know that maybe some money has been left on the table but this is better than incurring a large loss at this point in my life."
Already retired, Douglas Johnson believes that maintaining ample liquidity to cover near-term living expenses will help him keep a cool head if and when the market eventually drops. "We are retired and increasing our cash, near cash, and short-term bonds to make sure we have five years' worth of withdrawals available. This will let us ride out almost any storm and spend our time on stuff more important than our portfolio--like spoiling grandkids. Markets always go down. This is an opportunity, not a problem, because they always come back."
In a market that has risen as quickly as the current one, rebalancing might be more of a process than a once-a-year maneuver. Win1177 shared, "We have become stock-heavy in terms of our asset allocation, mainly due to the terrific rise in the stock indexes over the past five years or so. I have been periodically taking some off the table, but the market has risen more than I have taken off, so we're still stock heavy. We now have to limit our income/ dividends/ capital gains to avoid going into the highest tax bracket (admittedly a good problem to have), so I doubt I will take any more off the table this calendar year, for tax reasons. Come Jan. 1, I will again take some more out of large cap U.S. stocks, and redeploy into under- represented areas in our asset allocation (emerging markets/ foreign stocks/ bonds (loading up on short duration bonds primarily, avoid long duration!)."
As TheDumberOne and others point out, selling appreciated winners isn't the only way to rebalance; you can also do so by adding to whatever hasn't performed as well. "I have been putting more of my dollar-cost averaging share into [my] stable-value fund and cash to bring portfolio balance to target. I'm not selling any stock portion and not planning to. I will sell if there is a pets.com IPO that opens at $1,000."
Ditto for Win1177, who wrote, "If we are underrepresented in a category, that is where I steer money. I am [also] having all capital gains/ dividends paid in cash now, instead of reinvested. This way I can steer them into areas below our desired target allocation."
DrBobb has simply stopped adding to stocks but will do some selling if the portfolio exceeds his equity thresholds. "I have quit putting new money into stocks. If the portfolio goes over 60% equities, I will sell stocks to stay below that level."
'Patience, Patience, and a Little More Patience'
Other respondents said that focusing on valuations is the key to avoiding market manias.
With not much looking attractive at current levels, Saveamerica is content to sit tight. "I look for companies selling for 50% less than their intrinsic value. I am not finding them much, so I don't buy anything."
Informed by valuation and quality considerations, and armed with Morningstar's equity research, JohnMidloVA has been moving money from fully valued names to more deserving candidates. "I have been cutting back on stocks that have risen above their fair value, and especially those with high fair value uncertainty ratings," this poster wrote. "I use the proceeds to move to stocks with low uncertainty ratings and wide moats with prices lower than fair value. Some of these are Enbridge (ENB), Coca-Cola (KO), and Baxter International (BAX). I will keep doing this gradually until the next correction."
Uncleharley is also adhering to an approach that has served him well in the past. "I intend to follow the same strategy that I have been following and that is to find value stocks that have some upward momentum. [Stocks with Morningstar Ratings of 4 or 5 stars] generally represent value and I use a handful of technical indicators to track momentum or lack thereof. That has worked for me in the past and I expect it to work in the future."
Several posters said they're licking their chops for the inevitable downturn. Finding worthy candidates to add to when prices are better has kept them occupied during the market's ascent.
Wrote CardsFan: "I read lots of articles about managers sitting on cash. I peek at my portfolio to remind myself of the rewards for buying when others are heading for the exits. I am looking at bonds again, especially FPA New Income (FPNIX). And then a few more if/when we are into tapering. I am thinking about what I want to get, or add to, when the markets do correct."
Vandy73 is taking a cue from corporations that are hoarding cash. "We have sold a few non-performing stocks and funds, and are holding the cash. We're following the lead of many funds and corporations that seem to be 'sitting on cash.' I figure what's good for the goose is good for the gander. Hopefully, they know more than I do."
For Matthew9, waiting for more enticing valuations requires "Patience, patience, and a little more patience. The fact that the market hasn't had at least a 10% decline in so long gives me great pause. Regardless of market valuations, the fact that we've gone this long without a double-digit decline goes against the law of averages. It will happen sooner than later and when it does, my interest in deploying available capital will truly increase. Right now I'm comfortable holding put and looking at holdings to trim."
