Morningstar’s vice president of research recently narrated a story that harks back to the Soviet Union. One woman saw another standing in a long line, snaked across two blocks. "Come, I saved you a spot," said the second. "What's in the store?" asked the first. "I don't know, but everybody seems to want it, so it must be worth the wait," responded the woman in line.
John Rekenthaler went on to draw an analogy with investing stating the same underlying reason why speculators purchased cryptocurrency. Bitcoin became desirable because people wished to buy it, and even more desirable when its price soared. The popular basis for owning cryptocurrency has been, quite simply, because today's quotes will be higher tomorrow.
The same goes with art. There is a difference between the commercial price of an artwork and its value. The price is determined by market conditions, size of the work, the medium on which it has been done, the artist, the rarity of the painting etc. The value is its perceived worth or a subjective opinion of the viewer and the demand. That is why at an auction, the actual price for which it is sold could be much higher than the reserve price estimated, simply due to competitive bidding which indicates demand for a product.
This can also apply to stocks. Think market price and fair value.
I believe all the above can be summed up in Peter Bernstein’s words: Your wealth is in many ways dependent on what other people will pay for your assets.
Let’s admit it. When it comes to equity today, you are getting paid very well. Which brings us to the question, should you sell?
Just because you have become accustomed to stocks hitting new all-time highs, it doesn’t mean this will continue forever. But then again, a liquidity-fuelled rally could stretch for a really long time. What I am saying is that it is tough to predict where the market is headed, and we have no control over that. But we can control our portfolio's risk exposure.
The length of the current bull market is uncertain, but the implications it has for your portfolio are not.
Are you in need of cash?
I know a few individuals who lost their job this year. If you find yourself in such a situation with no Emergency Fund, you may need to liquidate some investments to help you tide this crisis. The positive aspect is that you are in the middle of an unprecedented bull run. Capitalise on it. Imagine the trauma of having to sell your equity holdings at a loss simply because you found yourself unemployed in the throes of a bear market.
Are you retiring in a few years?
If you are saving for retirement 20 years down the road, there probably is no reason to sell. But if you are five years away from retirement, it is certainly wise to begin offloading your equity holdings.
Are you a retiree?
Given the low interest rates and stocks climbing such highs, retirees could trim their equity exposure a bit and move the proceeds into cash to meet living expenses.
Have you rebalanced your portfolio recently?
None of the above may apply to you, but honestly ask yourself if you have let the market's rise drive your equity allocations higher. If yes, your portfolio is much riskier than what you intend it to be. It would be wise to ease up on your equity allocation.
People often put off asset allocation. There’s inertia exacerbated by human beings’ natural aversion to messing with a good thing; the bull market has been a boon to portfolio balances. But if you haven’t been actively trimming your portfolios’ stock positions, and if you have been actively adding to stocks amid the runup, your portfolio might be dangerously out of sync with your pre-determined asset allocation.
Your current portfolio must resemble the appropriate blend of risky and safe assets. Letting a portfolio run in a raging bull market could lead to a portfolio with a higher drawdown risk because of its higher equity allocation. And if you do not rebalance, the recovery period would be much longer because the portfolio has to climb out of a deeper hole. As explained in a basic primer to asset allocation, those who invested in mid caps saw their portfolios grow 2.5 to 3 times between 2014 and 2017. Instead of withdrawing, people kept investing more into small and mid caps. Then came a 50-60% correction up to April 2020. If they had cut down their exposure after the sharp run up, they would have protected their portfolio from this drawdown.
The journey of a buy-and-hold portfolio can be tumultuous, but rebalancing can help smooth out the ride. But as explained, the rebalancing need not be only between asset classes, but also intra-asset class. Maybe you need to ease off on your small-cap holdings.
Are you confused?
If you don’t think the market will rise much longer and would like to book profits, but are still tethering on uncertainty, use the principle of regret minimization. It helps give direction when facing trade-offs. Sell or hold? Buy or wait? Follow it up with: If I end up making a mistake, which mistake will I regret less?
I often keep a checklist when I want to sell a fund or a stock.
- What action will move me closer to my long-term goals?
- Has anything fundamentally changed with the investment that I want to sell?
- Has anything fundamentally changed with my goals?
- Has anything fundamentally changed with my investing strategy?
- Has anything fundamentally changed with my risk profile?
- What would be the tax implications of me selling?
- If I sell, do I know what to do with the money? Is it because I need the cash or I have to put the proceeds elsewhere?
Investment Involves Risk of Loss.
