If you’ve been watching the U.S. stock market lately, you know that it’s hovering near all-time highs. The Dow is within 2% of its October 2007 high, and the S&P 500 is not far behind that. The S&P has bounced nearly 125% off its March 2009 low. Investors holding bonds have done very well over the last 10 years, bonds are also at new highs. And for the first time in years, money is flowing back into stock mutual funds.
All of this has some people worrying that we’re heading toward another pop of the stock bubble, although others see it as the beginning of a longer trend upward. There seems to be a little more consensus on bonds, that they are poised for a fall as interest rates are expected to rise at some point; which would take a big bite out of the value of bond holdings, especially those with longer durations.
So if you think stocks are overpriced and you sell to beat a crash, how would you feel if next year finds the stock market even higher? If you hold on to stock and bond funds and we do get a big tumble in both, how would you handle that? And even if you sold everything now, where would you stash the proceeds?
I have no idea what’s going to happen. But I read Jason Zweig’s piece in the Wall Street Journal a couple weeks ago suggesting that we take this moment to design a portfolio that will make us happy (or at least less sad) under any market conditions. Instead of trying to predict the future, the idea is to allocate your assets across “buckets” that diversify across various economic outcomes:
"Thinking about diversification in a different way—what we might call "differsification"—might change your views entirely. Instead of spreading your bets to protect against a plunge in the U.S. stock market, you should regard your portfolio as a set of bets on basic economic conditions and create one bucket for each: expansion, recession, inflation and deflation."
Read the full article for suggestions on how to design your own buckets.
This got me thinking abut what steps can I take now, now that I’m pretty much back where I started five years ago, to make sure I’m at least content no matter which way the winds blow. Here's my plan:
Make sure my asset allocation is appropriate for my risk tolerance.
As I’ve lamented before, my asset allocation was a little equity heavy in 2007 for what I learned in 2008 was my actual tolerance for risk. I’m shifting from a 70/30 allocation of equities to bonds and cash to a 60/40 allocation. Sure, the market may go higher, but at these levels, basically where I was in 2007, I now get a chance for a do-over. My allocation is now where I wished it had been in 2007.
Make sure my allocation is still where I designed it to be.
No matter what risk-appropriate allocation you designed for yourself, after January’s 6% rise in U.S. stocks, your intended allocation may be out of whack. It’s hard to sell stock when they're high I know, but that’s the beauty of periodic rebalancing. It forces you to do what you might not feel like doing.
I’m paying off the mortgage.
When I retired five years ago, I hadn’t paid off the mortgage. I had the cash set aside in a CD that paid a higher rate than my mortgage rate. And after the market tumbled non-stop, I was pretty happy I that didn’t use up that big chunk of cash. As it turns out, I needed it to live on during that roller coaster time. If I had paid off the mortgage, my only alternative would have been to sell stock at rock-bottom prices to fund living expenses over those years.
Of course in retrospect, it would have been a better move to sell stocks on day one of retirement and pay off the mortgage. That would have prevented that chunk of my portfolio from nose-diving, as it would have been safely stashed in my house.
But now, just as then, I have no idea what direction the market is going. But I lock in a 2.875% return on that money if I pay off the mortgage now. It doesn't sound like much, but as opposed to 2008, that’s more than I'm earning in cash accounts now. Who knows whether it’s better or worse than what I’ll earn in the stock and bond markets. Which is why I’ll be taking the money from both sides of the equation in 60/40 proportion. I’m not trying to time the individual markets, just take this moment to keep in balance. I'm basically rebalancing into my house, something that will give me comfort no matter what happens with the markets.
Today the market shed the last two weeks of its gains. With congress just about to head into another series of Washington-manufactured crises, it’s tempting to try and outsmart the market in advance. But those investors that tried that during the European debt crisis or before last year’s fiscal cliff negotiations have missed out on some pretty nice returns. I prefer to take a break from following what's going on in Washington for the time being. I'll just take my do-over and hope for the best.
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