Sometimes winning is not always pretty. Everyone enjoys a high-scoring sports game with exciting offensive plays. With the current record run on Wall Street in one of the greatest, if not the greatest advance in history, the markets have certainly provided investors their fair share of excitement. The record appreciation has resulted in over 300+ % gains from the lows of 2009.
Investors who stayed the course from the bear markets of 2008-09 have been handsomely rewarded for their patience. This is another example of why patience and discipline are required to be a successful investor. The Great Recession was a brutal downturn that was actually caused by the financial markets resulting in a severely stressed and illiquid banking system. This left the Federal Reserve having to backstop the whole banking system and credit markets with their version of quantitative easing.
Fast forward from those dark days; we now have record low unemployment, record corporate earnings, and a much stronger banking system and economy. The markets are currently reflecting these positive current fundamentals. What are investors to do to protect these large unrealized gains in the accounts? How does one play defense?
I come from an athletic background and know there are two ways to win a game. Ride the offensive hot hand and score a lot of points, or strategize how you can stop the other team’s best players from scoring. Growing up in Baltimore, I think about the great defenses of the Baltimore Ravens, with Ray Lewis and Ed Reed making plays to thwart other offenses.
Most investors think playing defense in the markets means selling stocks and going to cash. While that may sound like a sensible strategy, is it really? We know markets are cyclical and unpredictable, so timing and selling create tax liabilities, loss of future compounding of those unrealized embedded gains, and figuring out when is the right time to reinvest in the markets.
Why not consider alternative strategies than selling and going to cash to increase the odds of your financial well-being and success? Here are some ideas to help you play defense in any market environment.
- ADJUST YOUR EXPECTATIONS. The S&P 500 has returned 15.8% for the last five years through 12/31/17 versus the historical average of 10%. Reversion to mean suggest that to get back to that average, the index may have to go through a period of underperformance for some future time frame.
- MAINTAIN BALANCE AND DIVERSIFICATION IN YOUR PORTFOLIO. When is the last time you rebalanced your equity portfolio? If you haven’t since the Great Recession, look at your current percentages and trim exposures for each asset class that exceed their target weightings.
- BUILD UP CASH RESERVES. With the Fed expected to continue to raise short-term interest rates in 2018, cash alternatives like money market funds or T-Bills have better yields than they have in years. I recently purchased a 1-month T-BILL for 1.35%. This cash reserve will act as a safety net for any unexpected or future expenses instead of liquidating market-related investments.
- SAVE MORE. Saving takes discipline, and adjusting your spending habits can be challenging. Since the markets are at an all-time high, are your expenses at an all-time high as well? Are there ways you could consider spending less, so you are better prepared for a lower return environment?
- EXPECT MORE VOLATILITY. Markets have been remarkably calm over the last 2 years. Markets generally have at least one annual 10% correction. The last 5% correction occurred in June 2016, and the largest correction in 2017 was only 3%.
- TURN OFF THE FINANCIAL NEWS. When markets turn down for some period of time, the news can act adversary on an investor’s nerves and health. Embracing a play defense mentality will help you maintain your patience and discipline to get rewarded when the next upcycle begins.