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The Case Against Selling Equities - Forbes

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Assuming that you’ve remained fully invested since last year’s pandemic-driven market lows and have periodically rebalanced back to your target asset allocation, your portfolio has grown substantially over this time frame. Following the sharp declines from the onset of the pandemic, the equity markets have been on a breathtaking tear, approximately doubling in value. You may be tempted to bail - at least partially - on equities and move to the safety of cash. You wouldn’t be alone. 

There are many legitimate factors that one can easily look towards as a reason for lightening up on market risks: the Covid Delta variant; the Fed rolling back its easy money policy driven by inflation concerns; the strong dollar relative to other fiat currencies; slower growth rates from China, just to name a few. An argument can be made that based on these factors, as well as a plethora of other reasons, equities currently are overvalued. Many market analysts, and television talking heads, are advising investors to lighten up on stocks because they believe the equity markets are, indeed, overvalued. Although I can make a cogent argument to either support or contradict this premise, doing so would be a waste of time as my opinion on market valuations is irrelevant. Rather than add to the noise, I’ll discuss why I’m not lightening up on equities regardless of that which currently is unknowable – whether markets are appropriately valued.  

I’m an unapologetic asset allocator. My recommendation is that you create an appropriate asset allocation for your portfolio, rebalance it when necessary, and ignore the plethora of market prognostications. This is difficult advice to follow in every market, as it is easy to be torn between locking in gains and cutting losses.  

By “an appropriate asset allocation” I mean one that is goals-based and thoughtfully balances risk and reward relative to your circumstances, not just an age-based “rule of thumb” asset allocation. Besides age, your asset allocation should consider both objective and subjective factors such as: your time horizon (when will you need to draw down funds, and for how long); your risk tolerance (over time, not just in the moment) your prior experience investing in various asset classes (investing in the unfamiliar is a prescription for anxiety); your current and anticipated lifestyle (expenses and other portfolio outflows); your non-portfolio sources of income; and your ability to replace lost capital.  

Once you decide on your asset allocation, as asset classes rarely rise and fall proportionally, it is important to periodically “rebalance” your portfolio back to its target. Rebalancing can be a test of fortitude, as it requires selling off equities when they are rising, and even more so, buying equities when they are declining. I recommend a thorough portfolio review and rebalancing back to your target at least quarterly, or more frequently when an asset class is more than 5% off its target.  

Although I don’t recommend modifying your target asset allocation based on market prognostications, it also should not be viewed as completely stagnant. Most of the inputs going into the construction of one’s asset allocation tend not to vary much over short periods of time, but sometimes they do. You should consider modifying your asset allocation to reflect longer term changes in your lifestyle such as retirement, relocation, changes in your family’s structure, and modifications of your life objectives.   

In March of last year, as equities were tanking following the onset of the coronavirus, I expressed my commitment to asset allocation in this column: “Coronavirus and the Markets: What Do We Really Know?” 

“Adjusting one’s portfolio to rebalance into asset classes that have declined is smart. Adjusting one’s asset allocation to reflect changes in long-term financial objectives, and evolving risk tolerances, always is appropriate. Going into cash out of fear, with the intention of coming back into equities at better valuations isn’t a strategy – it’s the definition of market timing, which rarely works out well.”  

Going back to my initial question on the temptation to sell equities because of concerns over market valuations, I find that reducing your exposure to equities is not going to be your toughest decision. Going to cash, especially to lock in gains, is relatively easy, even if at a significant tax cost. The tougher, and more complicated decision is: “when do I reenter the equity markets?” Unless you intend to change your long-term asset allocation, going to cash is a temporary decision. Before doing so, you need to ask yourself: What does reentry look like? Generally, the quick answer is: “at more reasonable valuations.” Based on my experience with clients going to cash, and intending to eventually go back into equities, rarely does any reentry point seem comfortable. Should equities continue to rise, even after a slight pullback, you may find it difficult to reinvest at a higher price point. Doing so can feel foolish for obvious reasons, including the very real fear of prices subsequently falling after you reinvest (your initial motivation for selling) and then getting whipsawed. Alternatively, should prices fall from where you sold, you’ll feel smart, but then may be asking yourself if they’ve falling enough for you to be comfortable with their lower valuations, and to offset the tax cost of having sold – think about the adage of catching the proverbial falling knife. Both outcomes challenge our cognitive biases.  

On a final note, be assured that at some point there will be a significant market correction — and it will be extremely unnerving when it occurs. And although it will be painful, equities will come back – eventually. And when they do, you’ll be rewarded for remaining invested.

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The Case Against Selling Equities - Forbes
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