By Charlie Farrell, Special to The Denver Post
With the stock market seemingly going up week after week — although showing a few cracks lately — lots of people who have been sitting on the sidelines are wondering if they should jump into stocks.
Is this a good time to dive into the stock market?
The first thing to note about this question is that if you’re asking it, then you’ve probably made some basic mistakes with how you manage your money. (I mean that in a nice way.) Don’t worry, most of us have made this mistake at one time or another. The key is to recognize it and fix it.
If you’re trying to figure out the “right time” to get in or out of stocks, you’ll usually do yourself more harm than good. It’s essentially impossible to identify the major inflection points in markets. Most people who try timing things perfectly end up jumping in after the market has already posted big returns and then jumping out when they get scared by the next decline. That’s the buy high-sell low approach, which is pretty much the opposite of how you make money. Do yourself a favor and don’t put yourself in this “no win” situation.
But what should you do today if you’ve shied away from the market and think you’re meaningfully underexposed to stocks?
The best place to start is to figure out how much money you’re willing to invest in stocks. Consider that stocks have great potential to deliver 7 to 10 percent long-term returns, but can also deal you a 50-percent decline on a moment’s notice. You have to accept both possibilities.
Most people struggle with this acceptance, and that’s what gets them into trouble when they look for “perfect timing.” Once you accept the risk parameters of the stock market and give up the timing thing, then you can allocate your long-term money to stocks.
What constitutes long-term money? In general, it’s money you don’t need for at least the next six to eight years. Your shorter-term money shouldn’t be in stocks.
How much of your long-term money should go into stocks? A good place to start is with a traditional retirement plan allocation that is about 60 percent invested in diversified stocks with the other 40 percent allocated to some form of high-quality fixed income investments, like CDs, Treasury bonds or a diversified bond market fund. This is an allocation that has stood the test of time. It has a larger emphasis on stocks for their higher return potential, but it has a meaningful enough amount in bonds to provide you with some defense.
You can then adjust this 60/40 split based on what you know about yourself. If you consider yourself more conservative, you may want to have somewhat less than 60 percent invested in stocks. If you’re comfortable with a more aggressive stance, then consider investing a bit more than 60 percent.
Now here’s the important part: Once you decide on your allocation, stick with it. Understand and accept that the stock market can provide good long-term returns, but to get there you often have to tolerate shorter periods of significant declines. That’s how you break the cycle of buying high and selling low. When markets crash, we all face the prospect that we bought too high. The key is not selling low.
If you run your numbers and decide that you should have more invested in stocks, how do you increase your allocation? Given that the stock market is somewhat expensive, you should consider doing it slowly, probably over the course of a year. For instance, if you think you’re 20 percent light in stocks, you could increase your stock allocation by about 5 percent each quarter for the next year. That way, if the market falls, you haven’t dumped all your money in just before a big decline and you’re buying as things get cheaper. And if it keeps going up, you’re at least investing periodically and capturing more of those gains as your allocation increases.
Stop worrying about whether you should get in or get out. It’s not worth the stress, and you can’t accurately answer the question anyway. The right way to do it is get in for the long run and stay in.
Charlie Farrell is a CEO of Northstar Investment Advisors LLC, and guides the firm’s investment philosophy. He is the author of “Your Money Ratios: 8 Simple Tools for Financial Security.” This article is for information and education purposes only. It does not constitute investment, tax or legal advice.