The graphic to the right, showing the top stories on MarketWatch recently, reflects how mixed views on the market outlook really are. Some experts predict a continuing boom, some a crash and some both. No wonder retail investors like you and I are confused on what to do. The stock market crash of 2008 is not that distant a memory, yet the fear of missing out on yet another market rally is just as palpable. So what does one do? Here are 5 things you could be doing to benefit from the rally, yet protect your downside.
1. Keep investing in your 401K or IRA – Long term investing is the best way to overcome short term volatility, and tax advantaged retirement plans are best way for most us to do this. So continue investing, to your maximum limit, in your 401K or IRA plans. Overtime stock markets rise and with the threat of inflation looming in the later half of this decade, equities will be one of the best asset classes to be invested in. Case in point: Equity markets had their best quarter in a decade, up over 10% in the first quarter alone. Most diversified retirement plans are up even more.
2. Keep your “buy-list” handy for when there is a correction - One thing I have learned is that what goes up, must come down. So if you missed out on the last rally, consider the next market correction a buying opportunity. But tread cautiously and avoid buying too soon on short-term moves. I have about 5 stocks that I closely watch and if they drop by 10 to 20 percent for non-company specific reasons, I will definitely hit the buy button at my online broker.
3. Sell half your position if your stocks double. If you have been fortunate enough to ride the latest rally, then don’t get overly greedy. Consider selling a portion so that you can recoup some of your initial investment and keep the cash on the sidelines to take advantage of the above point. I use a rule of thumb where if the stock has doubled, I generally sell half so that I recoup my initial investment. This way I keep the upside benefit if the stock continues to rise, yet limit my downside because I am invested with capital gains rather than my own hard earned savings.
4. Diversify. If you want to reap some of the benefits of a rising stock market, yet want to sleep soundly at night then diversification is your best bet. And the best hedge for equities right now are bonds. Bonds offer both stability and diversification because when stocks go down, bonds do well. Further they don’t tend to perform as bad when stocks are rising since their yields improve. In particular, consider high-quality corporate bonds (via an ETF is probably easiest) which provide considerably higher interest than Treasury bonds for marginally more risk. You can check out Morningstar for free reviews and performance history of leading bond ETFs.
5. Avoid the so called “market experts.” A final piece of advice for when you are uncertain where markets are going to go is to moderate how much you listen to the various talking heads on TV. It is amusing that celebrity stock experts on channels like CNBC can look at the same set of facts and draw varying and often opposing conclusions, that also seem to change in the span of a few days. Instead stay focused on your longer term investment plan and goals. Do your own research before buying or selling, because free tips and advice are often worth as much as you pay for them.