I made a prediction in January at the Weiss Wealth Summit in Palm Beach, Florida: I said publicly that U.S. equity markets will go higher — possibly much higher. And now, six months later, I’m ready to make another forecast.
So far this year, the Dow Jones Industrial Average and the S&P 500 are up more than 20 percent, having hit record highs last week. For most of 2013, investors have been in a buying mood as Federal Reserve Chairman Ben Bernanke has consistently reaffirmed easy-money policies.
But as I have warned, those policies — official interest rates near zero and trillions of dollars in bond buying — can’t go on forever.
Other investors are beginning to think the same way. When Bernanke announced the Fed may reduce, or taper, its monthly bond-buying program, U.S. stocks reacted badly by falling more than 5 percent over the course of a few days.
Bernanke then explained that the central bank was not considering an immediate shift in policy. So stocks rose again.
My view now is that the U.S. stock market is more likely to fall. And without the support of the Fed, it undoubtedly will go lower.
So, given my expectations, what should an investor do?
|A one-size-fits-all strategy can’t be applied to every investor in this environment of artificially low rates.|
The answer to that simple question is tricky because it has as much to do with investor psychology as it does with time-tested financial principles.
As I have pointed out, a one-size-fits-all strategy can’t be applied to every investor in this environment of artificially low rates. That’s why investors, now more than ever, need to assess their own financial circumstances and ability to take on risk before making their next move.
For those who have waited on the sidelines and think they have missed out on this big market move up, I would say to remain patient.
That’s because I think you will get a chance to buy stocks at lower prices. Moreover, your investment behavior tells me that you are cautious and risk-averse.
Investment losses make risk-averse investors feel bad. In fact, when given a choice between two uncertain outcomes, cautious investors are about 2-1/2 times more averse to losses than they are happy about a similar-sized gain.
To study the psychological impact that losses have on cautious investors, economist Paul Samuelson constructed an experiment in which he offered to pay his colleagues $200 if they correctly called heads or tails in a coin toss and, in return, he would collect $100 for each incorrect call.
Most people didn’t accept the offer — even though they had a one-in-two chance of doubling their investment. The most common response was: “I won’t do it because I would feel the pain of the $100 loss more than the joy of a $200 gain.”
So if you are cautious and risk-averse, wait a bit longer to enter the stock market because you will likely get the opportunity you have been waiting for.
If you are invested and have already made some money, my advice is to lock in some gains and take some money off the table.
I’d recommend dollar-cost averaging your way out of the market as stocks go a bit higher. The amount and timing of the withdrawals should be a matter of your own experience, knowledge and judgment.
After all, the markets have rewarded your bold actions, and it’s time to bank some profits. Moreover, your actions tell me that fear of loss isn’t a primary motivator for you so you should stay in the game with some of your profits and let them run.
Bernanke has no choice but to continue to provide the markets with monetary morphine. That’s a certainty.
Given these conditions, your primary concerns should be: How does that affect your money and what actions you should take? The answers have as much to do with psychology as with trading strategy.
As financial writer Adam Smith said about Wall Street in The Money Game: “If you don’t know who you are, this is an expensive place to find out.”
In next week’s Money and Market’s column, I’ll explain to cautious, risk-averse investors how they, too, can profit in an equity market that’s growing vulnerable to a setback.