Save money and investment concept. Closeup piggy bank and silver coins falling. 3d rendering illustrationmarchmeena29/iStockPhoto / Getty Images
There’s a decent chance you have too much money in stocks.
Stock markets are positively sizzling and a bevy of indicators suggest retail investors are increasingly eager to get in on the action.
Canadian households currently have nearly half of their financial assets tied up in equity investments, which is just about as high a proportion as it has ever been, according to Statistics Canada data.
The retail trading boom that took hold in the height of the pandemic is still going strong. The popular U.S. investing app Robinhood has seen its active user base nearly triple from prepandemic levels, while its total assets under management have spiked more than seven-fold.
This isn’t much of a surprise.
Major bull markets have a way of morphing into cultural movements, capturing the attention of hordes of amateur investors chasing easy money.
“I find the general public is pretty plugged into financial news right now,” said Kurt Rosentreter, senior financial adviser at Manulife Wealth. “The longer it goes on, the more people you see looking to pile in and increase their stock exposure.”
And they have been handsomely rewarded for their exuberance, for the most part. Over the past year, the S&P 500 index is up by 35 per cent. The tech-heavy Nasdaq Composite has gained 40 per cent.
Even Canadian stocks, long laggards to their U.S. counterparts, have lately started to catch up to the frenzy. The S&P/TSX Composite Index has risen by 27 per cent over the past year.
The problem with portfolios that are heavily concentrated in stocks is that they are vulnerable to selloffs. And you don’t need any high-minded market predictions to know that one is coming.
U.S. stocks are on a historic run dating back to the global financial crisis. A few blips notwithstanding, the S&P 500 has delivered average returns of 15 per cent a year after factoring dividend payments.
That incredible rise has elevated valuations to the extent that, over the last century, U.S. stocks have been pricier than they are now only 3 per cent of the time, according to a recent Goldman Sachs report.
Of course, they can – and probably will – get more expensive still. Strong corporate earnings can also extend the run indefinitely. But eventually, even the mighty U.S. stock market will revert to its mean.
Fortunately, there’s a basic but elegant move that can offer some protection from the inevitable.
Rebalancing mostly involves making simple tweaks to bring one’s investments back in line with target allocations. It might mean moving money out of stocks and into bonds. Or reducing holdings in a specific sector or individual company that have become disproportionately large.
It’s a surefire way of reducing portfolio risk. But it can be counterintuitive for many investors, since it inherently involves cutting one’s biggest winners and picking up underperformers. Or moving some money into something safer like a guaranteed investment certificate.
That can be a tough sell in a hot market.
In fact, lots of advisers these days are finding their clients pushing in the opposite direction, and asking to have their risk tolerance levels bumped up in order to increase their stock holdings, Mr. Rosentreter said.
But risk tolerance is supposed to be a function of factors like age, income, retirement goals and level of financial sophistication. Not one’s confidence that the stock market is going to keep cooking.
“That’s just greed rearing its ugly head,” Mr. Rosentreter said.
Portfolios can also get unintentionally out of whack. As stock markets rise, those gains can cause allocations to drift. Pretty soon, a 60-40 split between stocks and bonds can become a 70-30 split.
Do-it-yourself investors who pick individual stocks might be overdue to rebalance, especially if they hold hot names like Nvidia Corp., which has more than tripled over the past year.
Rebalancing one’s portfolio is an extremely unsexy antidote to making outsized bets on hot stocks and artificial intelligence. But it works.