Stock market gains could quickly turn to losses if not cashed in

Stock market gains could quickly turn to losses if not cashed in
10 July 2013

A friend spoke with me this week about his retirement planning. Excluding property, which he will live in as long as he can when he retires, about 80 per cent of his investments are in the equity market. He wanted to know: “Is this high risk and should he be cashing out of equities now when they are at record highs?”

My friend is approaching the big 5-0 next year and each year aims to increase the contributions into his pension pot. He recently realized, after a lengthy illness, that carrying disability, health insurance and long-term care insurance through retirement are two essential considerations. Many of us will not have much, if any, government support when we retire and what parent wants his or her own needs to be a significant financial drain on a child’s resources?

Current pension portfolio

One of his investments, which accounts for about 15 per cent of his portfolio has risen over 230 per cent in the last twelve months. Should he sell or will it continue to rise? Another, which accounts for 18 per cent of the portfolio has risen 120 per cent but looking at the share price it is still 35 per cent below book value. The average return on his portfolio, excluding the stock, which has risen 230 per cent, is just over 72 per cent in the last twenty-four months. He also reinvests the dividends.

The fact is that huge increase means nothing if he doesn’t cash in. It is a paper gain.

But when to cash in and if he does so how to rebalance his portfolio to meet his goals?

Traditional thinking

At this time of life he should be considering reducing the risk elements but frankly the returns on the perceived historical low risk investments, especially government bonds, is probably below real inflation so he has virtually zero invested in them 

Equity markets have grown significantly over the last two years, but bonds and precious metal investment have either returned near zero rates of interest or lost huge value.

If he was to follow the classic investment theory of 50 per cent equities, 30 per cent bonds, 5 percent alternatives and the rest in cash there is no way he would achieve his goals. His retirement fund includes nominal bonds and no precious metals, but the nominal amount of bonds, and their low returns, has impacted the overall spread of returns and left him asking key questions.

Getting the balance right

Nothing in life is guaranteed, and we’ve seen what devastation an economic downturn can have on retiree’s pension fund and life. However my friend monitors his stocks daily, it is a portfolio of about 10 individual stocks and he does not rely on a money manager. He also feels confidant with tax planning into retirement as the European country he lives in has generous tax benefits with shares and retirement planning. 

Should he cash in now when stocks are at record high levels? Looking at the stocks he has selected at least two are possibly ‘expensive’ at the moment and I would expect a correction downwards of at least 30 per cent in one of them, although it is seen as a very good investment by analysts with further long term growth. He has considered cashing in now and buying again when the shares correct downwards, but as a long term value investor he is against this route, preferring to stick with it for the long term – in other words he is not so convinced it will correct downwards.

Good time to buy or cash in?

It is true that as an investor you don’t want to see your paper gains erased just because you wanted to hold out for something bigger. Because if you get greedy, you might be left with nothing.

Overall his equity portfolio, which is mainly US blue chip listed companies and former ‘distressed stock’ from the crisis, is likely to see continued growth and he has set maximum targets for selling, based on increases and decreases against each stock. Essentially his timing would seem to have been good, as he bought low.

If he was to sell up where to re-invest to ensure his retirement goals are met? Bonds are producing very low returns, some bank accounts in Europe still offer between 5 and 6 per cent interest with no tie-up, but essentially these are still low margins against what he is achieving in the stock market. 

Furthermore, if he did sell any shares is this a time to buy other stocks? Many stocks have risen significantly over the last two years, personally unless I am very comfortable with the forward cash flow projections and other key numbers I would say be very, very careful investing in any stocks at this time.

As I said my friend is able to almost work exclusively in the financial markets so he has the time and knowledge to monitor his investments. Yet he is regularly seeking, and acting on second opinions to ensure the right balance as he moves towards his goals. 

My own recommendation would be to move some investments, especially part of the bonds and cash, into low cost index linked accounts

Being responsible

It is critical to regularly review pension planning to see if you need to make a few adjustments to keep ahead of your goals. Keeping ahead of goals is not easy, especially with the rising cost of every day goods and property, but nevertheless regular retirement planning is essential and may call for cuts in other areas to ensure you have enough put aside.

Leaving what happens to the winds hardly seems to be what responsible adults should do. How often do you review your retirement plan?

Comments

  • Colin
    Colin
    2013-07-10T16:27:28

    cashy contributor, Carl Richards latest article in the NY Times reiterates many of the points my friend has taken. First he separates decisions from emotion. Carl writes: “I’ve often said that I’m great at making unemotional decisions when it’s another person’s money. But when it comes to my own money, it can be a struggle. Warren Buffett is a perfect example of this principle. Mr. Buffett has said over the years that he tries to be fearful when others are greedy, and greedy when others are fearful. That is essentially putting into practice the notion of “buying low and selling high.” And it means sticking with a plan even when it’s painful (for instance, when stocks suddenly jump or slump).” 

    Secondly he says: “I suspect most of us have a bias toward action, especially if we think we’ll look stupid if we stand still. The best behaved investors understand that it’s in their best interest to do nothing most of the time, even though everyone else around them may be saying otherwise.”

     

    Having a plan and sticking with it, whilst analyzing regularly is very important for retirement planning.

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Head of Behavioral Finance
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