When is the best time to plan for a stock sell-off? When the indices are hitting new highs, of course.
Rarely do investors consider defensive moves in their 401(k)s when stocks are rallying, but that is precisely when you should begin thinking about diversifying your investments.
When stocks get squirrely, I recall a comment from my old colleague, Noel, who used to declare, ‘Well, it’s either the warning bell or the dinner bell.’ More often than not, as we have discussed in previous columns, it’s the dinner bell.
From the time I began investing in 1987 through last year, stocks, as measured by the Dow Jones industrial average, have generated positive returns in 27 of 33 years, or 82% of the annual periods over that time span. That stretch includes Black Monday in 1987, when I began my career, the 2000-2002 market slide and the bear market in 2008 through March 2009.
All of that proves that stock sell-offs usually provide a golden opportunity to heap more holdings onto your plate at lower prices. By the way, the cumulative total return from Jan. 1, 1987, through the end of last year was 3,415%.
An event like Black Monday, my friends, was an epic dinner bell.
Buy low, sells high with your 401(k)
If you, like me, believe stocks are still in a long-term bull market, then meaningful downturns (think Q4 2018) provide a happy opportunity to look at our 401(k) contributions and allocations with new eyes. The hardest part of investing is to be a buyer of stocks in a falling market and a seller in a rising one. It just feels wrong. But it works.
When stocks begin their inevitable slide (markets experience a correction of 5% to 10% in just about every annual period), increase your contribution level to your 401(k). It simply makes sense to buy more of something when it is cheaper. You can dial your contribution back once the market rallies if you must, but you will have used the weakness to increase your purchasing power. This will be a powerful contributor to total over a 401(k) lifetime.
Add a fund that invests in dividend-paying stocks with proceeds from your soaring growth fund. The most important consideration is a fund that invests in companies that grow their dividend each year. No longer just associated with electric utilities and industries that grow when the economy is strong – dividends are now paid by technology companies like Microsoft and Apple as well as those like Starbucks and McDonalds that have long been categorized as growth stocks. The advantage of investing in these stocks is that the companies tend to grow the dividend faster than the traditional dividend payers. A second advantage is the power of compounding growing dividends enhances total return and provides natural protection in declining markets.
Rebalancing your allocations
Don’t forget the rest of the globe. The U.S. is frequently the best house on the global block. But global markets can provide additional diversification and total return. This may be a good place to invest when U.S. stocks are hitting historical highs.
You should also rebalance holdings that have appreciated far above the initial target you selected. Outperformance is good. But you don’t want the market making your asset allocation decisions for you. If you determined to place 50% of your 401(k) in a particular fund, allow it to run, but if it gets to be more than 10%-15% above your initial allocation, trim it back and transfer the money to a fund that offers fresh diversification or may have lagged recently. Again, you are increasing your purchasing power.
It is true that being invested through good years and bad provides a compelling total return. Never succumb to the siren song that convinces us when stocks are rising that they will continue to do so. Nor should you yield to the temptation to sell out when stocks are declining. Having sold stocks at the end of the painful bear market of 2008 would have cost you the opportunity to enjoy the 333% that stocks returned (again as measured by the DJIA) from Jan. 1, 2009, through last year.
Your 401(k) is meant to be invested for the long term. But you should be an active participant in your future. Consider the old investing maxim that exhorts investors to buy low and sell high. Tuning out the noise will allow you make important adjustments to your investments at turning points.