Is your portfolio in trouble?
As skeptics have been saying for years, stocks are expensive. For more than a decade, equity markets have been on a continual rise despite claims of overvaluation.
Yet, markets eventually revert to reasonable prices over time — eventually.
How should you invest today? Should you sell your stocks and get back in after the next correction? Or should you stay the course and keep an eye on the future?
Your needs matter Investing today is all about benchmarks. Mutual funds, hedge funds, and individual stocks are constantly compared to an index such as the S&P/TSX Composite Index.
This reality has several strengths. First and foremost, it keeps your fund managers and executives accountable for generating above-average returns. You can always buy an index fund with little to no fees, so why pay more unless the prospective investment can beat the index?
There is one major issue with benchmarking, namely, that it reduces your ability to dictate the rules.
At the end of the day, it’s your money. That money needs to work for your life. Your ultimate benchmark should be what you require for your lifestyle and needs, not whatever the broader market happens to be doing at the time.
When stocks are expensive and global tensions on the rise, it’s the perfect time to revisit your portfolio’s goals and requirements. Aggregate all of your holdings to gain a clear picture of your financial profile.
Do your investments match your expected time horizon? How resistant is your portfolio to market-wide downturns? Will you run into day-to-day financial trouble if your portfolio loses 30% of its value?
Revisit these basic questions of how much money you have and what your expectations are. If you can’t withstand a market downturn, prepare accordingly. If you can stomach the volatility and have a long-term horizon, you can likely sleep easy.
Nothing is equal Keep in mind that just because markets are frothy doesn’t mean you have to sell all of your stocks. Trimming the most vulnerable investments can still go a long way without eliminating your upside completely.
Which stocks are most vulnerable to a correction? As always, the first targets will be small-caps and growth stocks.
Small-cap stocks are often hit harder than large-caps. First, they have less analyst coverage. Second, they’re typically more vulnerable to losing a major customer or two. Finally, they don’t have the balance sheets necessary to borrow at cheap rates during a bear market.
Growth stocks are vulnerable not because they’re low-quality companies, but because there’s more room for the valuation multiple to compress.
Take Shopify Inc (TSX:SHOP)(NYSE:SHOP) for example. Shares trade at a sky-high 30 times sales. In a bear market, this could easily compress to 20 times sales, which still represents a gigantic premium over the market. Even in that scenario, the stock would have 33% downside.
Look at your portfolio line-by-line and determine where your risk is highest.
Don’t be smart Investors often think they can outsmart the market. Over time, nearly all are proven wrong.
For centuries, markets have been difficult to time. The game hasn’t gotten any easier in recent years. If you plan to sell your stocks high and rebuy them months later at a cheaper price, think again. More often than not, you’ll be buying them back in at a higher price.
While it may be prudent to reallocate your risk depending on your needs, the best course of action is typically to stay the course.
Tom Gardner owns shares of Shopify. The Motley Fool owns shares of Shopify and Shopify. Fool contributor Ryan Vanzo has no position in any stocks mentioned. Shopify is a recommendation of Stock Advisor Canada.
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