If you have an investment portfolio and a significant portion of it is in equities, you probably rejoice when the stock market is running strong and you see the value of your stocks rising. When things are going our way, it is natural to feel good. There can, however, be a downside to this.
What could the downside be to seeing your investments do well? Two things come to mind:
1.) The first thing that comes to mind is lifestyle creep. This can happen when we make more money at our job or feel wealthier do to our investment portfolio increasing in value and, consequently, we begin to live higher on the hog.
Now, you might ask, “Isn’t the point of making more money and building greater wealth so that we might enjoy ourselves more?” Certainly, doing better economically can give us the ability to expand our lifestyles. Whether that will make us happier is a question for another day. However, before we begin to spend more money because we feel wealthier, shouldn’t we consider the sustainability of increases to our income and our wealth?
What I am getting at here is that just because we might be doing well as a result of our stock investments gaining ground, it does not mean that they will be increasing this way forever. Consequently, we would be well advised to steel ourselves against lifestyle creep.
Sure, as we become more financially able we might want to take advantage of our resources so that we might live some of our dreams. However, we might want to think about sustainability before we embark on any lifestyle expansion. After all, building wealth is a lifetime endeavor. And it pays to remember that wealth can be dissipated faster than it can typically be built.
2.) The second issue is largely psychological. When we see the value of our stocks rise, particularly month after month, we get used to seeing increases and better numbers on our brokerage statements and online accounts. At some point we may forget that the market fluctuates in value and that what we see on any given day is but a snapshot of value, particularly if our gains are “on paper.” That is to say, we have not yet sold the positions in question and actually realized a profit.
There is nothing wrong with enjoying watching our investments go up in value. However, that is no replacement for sound and sober thinking along with diversification within and among asset classes. And remember, sound thinking and diversification are no guarantees that we will be able to make money or adequately protect ourselves in the face of adverse circumstances.
I would suggest that one way of looking at our positions, especially in a long running bull market, is to mentally mark down what we are seeing by no less than 20%. Why? Because at some time a bull market may well turn to a bear market and bear markets are typically considered to occur when the market loses 20% of its value when compared to its 52-week high.
How would you feel right now if your equity positions were worth 1/5 less? You would probably feel less wealthy. In a crash, equities might lose significantly more than 20%. If you feel less wealthy minus 20%, how might it make you feel if your account lost half of its value? Or more?
Please understand, I am no pessimist or party pooper. That said, I am a believer that we must be vigilant with our nest eggs and not get so swept up that we forget to protect ourselves, to the best of our abilities, against what history suggests are the inevitable declines that we might see in the market place.
Hedge fund manager Ray Dalio says that effective investing is about being offensive and defensive at the same time. If we’re not offensive (to some degree) we won’t make money, but if were not also defensive, we won’t keep money.
So enjoy watching the value of your portfolio increase, if that is what it is doing. At the same time, understand that nothing lasts forever, including bull market runs. History teaches us this. And although past performance is not necessarily indicative of future success, the history of the stock market can be sobering for anyone who thinks they have discovered a magic money tree.
Bull markets end. That need not be the end of the world for a person who plans appropriately. And though no plan is perfect, it is better to have a plan that utilizes some time honored guidelines than simply leaving things to the winds of fortune.
You might want to discuss the state of your investment portfolio with a qualified financial services professional.
Scott R. McGimpsey February 15th, 2018
This material was prepared by Scott McGimpsey and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources, however, we make no representation as to its completeness or accuracy. Neither Summit Brokerage Services Inc. nor Scott McGimpsey is engaged in rendering legal, accounting, or other professionally services. If such assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any federal, state, or municipal tax penalty. Moreover, a diversified portfolio does not assure a profit or assure protection against loss in a declining market. UNIFIED PLANNING GROUP is an independent firm with securities offered through Summit Brokerage Services Inc., Member FINRA, SIPC