Investor optimism has greatly improved over the last two years and it is easy to see why. The world’s equity and commodity markets have enjoyed a dramatic charge upward since the darkest days of the financial crisis in late 2008 and early 2009. While such positive sentiment is by no means unanimous, optimism clearly has climbed and many investors have been chasing these strong returns by moving back into the equity markets and increasing exposure to hot investments like small cap stocks, emerging market stocks, precious metals and other commodities. This is hardly a surprise given the aforementioned strong period of gains. At that same time this new found comfort with so called “risk assets” may not be an entirely welcome development. I am still a believer in owning “risk assets” for the long term. However, I do think now would be a good time to see how the last two years of strong performance have changed the risk profile of your portfolio.
Markets are frequently most at risk of a decline when the majority of investors are feeling very comfortable. Changes in the level of investors’ optimism or pessimism towards the future can often be the cause of market volatility. When times are good the natural reaction to such strong gains may be to “let it ride” or even increase exposure to the things that have done the best. This can often times be detrimental to portfolio returns and risk level.
A good example of this was in the year 2000. If you recall, there was very high levels of optimism about the future of the stock market. We were in a “new era” where the old rules regarding stock valuations did not apply. This elevated level of optimism tempted many investors to increase their allocations to stocks even though the monumental gains in the market had already done this for them. The “New Economy” train was leaving the station and you didn’t want to get left behind! We could say the same thing about the housing boom and bust we have experienced recently. Prior to the bust, investing in housing became much too popular and it felt like the good times where never going to end. As we now know, the greatest boom ever in housing ended with the biggest bust ever. Presently, the love affair with precious metals seems to have gotten a bit too strong and, at this writing in early May, we are seeing a sharp correction in silver prices.
These examples illustrate the importance of reviewing your mix of assets from time to time. Rebalancing the mix back to an appropriate risk level will help an investor guard against being overexposed to asset classes that may have become overvalued. This is especially important at moments like now when we have had an extended run of positive returns in many types of investments. I do not advocate trying to time the market and I am not recommending you get out of top performers completely. My advice is to take some profits from the areas that have grown the most and reallocate those profits to the asset classes that have lagged.
Damien helps individuals invest and manage risk. He is a CERTIFIED FINANCIAL PLANNER™ professional and a principal of Walnut Creek Wealth Management. These are the views of Damien Couture, CFP® and should not be construed as investment advice. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Your comments are welcome. Damien can be reached at 925-280-1800 x101 or Damien@WalnutCreekWealth.com.
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