Last Wednesday, the stock market rallied on Donald Trump’s speech to congress. We’re a little more than two months into the year and the Dow and S&P are already up 6.0% and 6.1%, respectively. Since Donald Trump’s surprising upset of Hillary Clinton, the Dow is up 14.8% and the S&P is up 11.4%. With such great performance, the question now becomes: what to do when the market is at all time highs?
Before discussing what strategies you might want to use, I wanted to scribble down some quick thoughts about the recent market rally.
As with many people, I find the surge unusual. The major indices have moved as if Trump’s agendas have been enacted. I think the most important policy he could possibly pass is lowering the corporate tax rate.
A reduction in the corporate tax rate (currently at 35%) would result in an immediate (and big) jump in the major indices.
However, tax reform is a big subject and any new regulation would probably take some time. Nevertheless, the market seems to believe it will happen.
1. Continue To Dollar Cost Average
There have been many great debates in the Personal Finance community about what to do when the market is at all time highs.
Some people believe that you should continue investing and not worry about ‘timing the market.’
Meanwhile, others believe you should take some money off the table or invest at a slower pace.
Neither approach is right or wrong. Investing should always be a function of your (1) lifestyle expenses, (2) risk tolerance, (3) dependents, and (4) and other important retirement factors.
For many people, the best and easiest approach is to continue investing through dollar cost averaging. By dollar cost averaging, you inherently “buy” the average market return over a long period of time. So if you’re happy with that, there’s no reason to shift strategy.
2. Invest In Undervalued Companies Or Sectors
If you’re somewhat skeptical or worried about the state of the market, an alternative strategy is to invest in undervalued companies or sectors. While the overall market has been strong, certain market sectors are still depressed.
One sector that comes to mind is oil & gas (which is still down about 50% below the peak 2014 levels). For the past year, I’ve shifted some of my excess cash into the oil & gas sector.
Another strategy is to deploy extra cash to invest in undervalued opportunities. I’ve found some interesting special situations that I’m attepting to take advantage of. Hopefully they pan out!
3. Hold Cash
Having a little cash is great when the market declines or corrects. A lot of people see cash as a “bad” investment. With inflation as a real threat, holding cash may seem crazy. Other people have a fear of missing out on a big stock market rally.
I always like to have a little dry powder to pick up the pieces when the market falls.
The funny thing is that people look forward to sales on consumer goods all the time. Great deal on a flat screen TV? Big sale on hot summer clothes? People will line up at 4:00 AM on Black Friday to get a laptop. However, when the major indices are down (i.e. “on sale”), they turn away!
Even if you buy the index during a correction/bear market, you’ll be sure to generate decent returns when things eventually recover.
To lessen the impact of inflation, I’ highly recommend putting extra cash in a high yield savings account. There are several options available to get a 1.0% interest rate on that money!
What Am I doing?
With the market at all time highs, what am I doing? I am actually doing a combination of all three strategies. I’m still dollar cost averaging into a low cost total market ETF. I’m also deploying excess capital into individual companies or even sectors that I believe are undervalued.
Finally, I’m keeping a healthy cash cushion. If the market corrects, I want to be there to get a good deal. If it doesn’t then I have some extra cash for other investments.
This is the #1 question to ask if you want to continue investing when the market is at all time highs:
Can I survive (or stomach) a 20% – 30%+ decline tomorrow if I invest today?
If the answer is no, then you should probably decrease the rate of your investments. If the answer is yes, then keep doing whatever it is you’re doing.
The stock market is a fickle (and sometimes bipolar) creature. Don’t get too caught up when it rallies. Conversely, don’t get too upset when it eventually comes down. The faster they rise, the harder they fall.
Always be prepared ahead of time. If you don’t have a plan before the market corrects, you’re too late.–because you’ll likely make decisions based on emotions. It’s always better to have a plan ahead of time when you’re cool, calm, and collected.
Alright, that’s it for today everyone. Happy investing!
PS. I’ll be putting out part 3 of my Stock Market Basics series sometime next week. I’ve been super busy lately on a few different projects! See you next time 🙂