Why you should not worry when the stock market hits an all-time high

Published: August 29, 2018 at 3:30 pm

Last Updated on

Each time the markets move up for a few sessions, it makes many investors uncomfortable. Is it a bubble? Is it euphoria? They wonder and if the movement results in an all-time time, the worry machines are turning in full swing. In this post, I discuss some reasons for this investor behaviour and how one can stop worrying about market movements by focussing on more important aspects.

I am running some numbers on market highs and this post (which was published earlier) helps set the tone and context. Worry and fear are unproductive because often people worry and fear when they do not know what to do. This perfectly applies to investing and portfolio management. If you hang around in a personal finance forum, you can see a pattern in the questions. Just consider the questions people ask or the remarks they pass when the market hits an all-time high.

1: Is this a right time to start a SIP? I am scared that the index has hit an all-time high.

2: I have some money to invest. Can I wait or invest now?

3: I have been waiting for a dip for the last 18 months, how long should I have to wait?

4: Is a correction imminent? After all, mean reversion* is due is it not?

* markets do not mean-revert because there is no mean to revert to, nor are they efficient. Well, that is another matter.

Fear of all-time market highs: Media manipulation has a role

At least one reason for the fear of All-time market highs stems from our susceptibility to media manipulation

All this talk reminds me of a quote from Live free or die hard

The news is completely manipulated. Everything you hear, every single day is designed by corporate media to do one thing only. To keep you living in fear

Nassim Taleb recently told a news presenter, “you are watching too much tv”! when asked to speculate on President Trump’s statements. Taleb said, “focus on what he does and not what he speaks”.

Our fear of market highs stems from taking the media too seriously, reading/watching too much news. If we knew how to process information effectively, we will stop reading the news altogether.

The media does not care about you. All they want is for you is to click on their stories. Look at the top stories featured today Google when you try to find out the movement in Sensex/Nifty.

markets at an all-time high: new stories sample snapshot

By manipulation, I am not referring to falsification (not here that is). Appealing to the fear and anxiety mechanisms of our brain with titles that bait, obscuring information and fact from opinion and speculation is also manipulation.

See a snapshot of three top stories today for 0.4% fall in the Sensex (29th Aug 2018).

The media cannot be entirely blamed as we have a choice of picking and choosing what we read. Unfortunately, something tells us that if we did not find out what those articles are about, we will be left out or lose out. Once that fear set in, panic replaces logic.

Seen this movie? From left to right (parts of our brain): Sad, Fear, Joy, Disgust, and anger. Joy can be the emotion in charge only when the others are kept in check.

inside out screenshot to show how people react to market all time highs
Screenshot from “Inside out”. Fair usage of copyright for commentary only.

The way I see it, investors are three types:

1: Those who have a plan and do not care about what the current value of the market is. Because their plan already factors in “trends” (including ignoring them altogether). They don’t need help. Unfortunately, many in this group are reclusive.

2: Those who wish they had a plan, but simply don’t know where to start.

3: Those who graze around aimlessly. Asan Ideas of Wealth will be quite useful to get “what to do now” opinions. Plenty of noise to swim about.

This post has a primary takeaway: it is not just important to invest as soon as possible, but it is also important to have a plan in place as soon as possible. Once there is a plan, you can ignore the media noise and stick to your course regardless of market all-time highs or lows.

I did not know this when I started but, I can now confidently state that “proper” goal-based investing will handle market risks efficiently and allow us to remain calm.

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What is “proper” goal-based investing?

That can be defined in two words: asset allocation. I know freefincal regulars must be tired of this, but investing starts and ends with the right asset allocation.

Asset allocation simply refers to: which asset classes should I invest in, and in what proportion, and how should I vary this proportion in time for my goal. This is actually a lot deeper than saying “for long-term goals, use a lot of equity”. We must understand risks well to choose the right asset allocation. Here is an example: How to create a retirement income plan for 27-year old Amar (Case study)

The second aspect is annual portfolio monitoring with an eye on “how much do I need for the goal now?” As mentioned in my personal financial audit 2017, I reset my equity exposure to 58-60% twice last year while the markets moved up. By keeping an eye on my asset allocation and not on market movements, I have now secured at least a few years of UG education for my son. Given that he is ten years away from college, that gives me time and space.  I have no need to worry about market highs or lows.

Read more: Deciding on asset allocation for a financial goal

This is portfolio management 101: choosing an asset allocation (say 60% equity, 40% fixed income for the first few years and gradually tapering down equity) and then review it once a year and reset it. After a few years of investing, you can rebalance twice a year (I have been investing for the last 8 years for his education).

Having a simple plan such as this (and having faith in it) is more than enough to ignore the market noise.

If you wish to reduce market losses further (not necessarily gains), you can move on to portfolio management 201 (not 102). This requires maturity at a different level. I would wager that only about 1 in 100 realise what “market timing” is not for return enhancement. Only 1/100 recognise that preventing losses does not mean more gains and that real life is a lot harder than what “sounds” like common sense.

By portfolio management 201, I am referring to changing asset allocation tactically. For example, decrease equity exposure from 60% to 40% when a moving average or a PE or a yield gap or a Motilal Oswal Value Index (MOVI) or any of the strategies that the dynamic asset allocation mutual funds practice or any number of asset allocation strategies available.

There is only one clause: these will help you lower losses almost everytime but may or may not enhance returns (that depends on when you started or the sequence of returns): See: Is it possible to time the market?

Why does this require more maturity? Because as recently argued – Don’t Be Fooled: SIP is NOT systematic investing! – SIP has nothing to do with discipline. Tactical asset allocation is hard because the only thing it requires is discipline (once you have faith in the method adopted). It requires a deep-seated maturity that it is neither possible nor necessary to capture the absolute market peaks or highs.

It is very hard to reduce equity allocation when you see markets zooming up and equally hard to increase equity allocation when the market is falling. It is one thing to back-test and quite another to implement in real-time.

How to stop worrying about market all-time highs

1: Never stop investing.  This is where most the problems lie. Notice that most people ask “is this a good time to invest?”. Wrong question. If they feeling like reacting to a market high (not necessary!), they should be asking, themselves “is this a good time to reduce equity exposure in my portfolio?”.

If yes, what is the trigger for decreasing equity allocation? What should be the trigger for increasing? Has any back-testing been done on these triggers?

For example Buying “low” with “active” cash vs buying systematically: still a surprise! or Misconceptions about the Nifty PE.

There are two advantages of investing systematically (automated even):

a: you do not feel regret that you have missed rallies. Minimising regret is as important as minimising risk in portfolio management.

b: you keep accumulating units or stocks. So when you have to make a tactical withdrawal, you will always have enough units which are old enough to reduce tax and exit load. Reducing such outflows is also important.

So the idea is: choose a system/method to manage risk —–> automatically invest + systematically reduce risk.

If you do this, there is no need to worry about “where” the market is. you can safely ignore all media noise and take decisions only by looking at your portfolio.

2: Always keep your goal in mind: How much do you need if you were to spend for it today? This gives you a sense of how much you have accomplished. If you choose to tactically change asset allocation, then make sure that there is a good enough amount of corpus in fixed income instruments at all times. This keeps you calm and confident. They are necessary to use your head.

A line from Tombstone that I say to myself all the time:

Keep calm, use your head and you will be all right.

Note: I would strongly advise new investors working towards long-term goals to stay away from tactical asset allocation. As your portfolio becomes bigger, you can consider tactical asset allocation based on a solid model.

To conclude, you should not worry when the stock market hits an all-time high because there are other and bigger priorities!

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About the Author

Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com

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4 Comments

  1. The world is in big debt and world economy will go one more depression as in 2008. We see economy turmoil in peripheral economic centre Greece , Turkey and soon Italy. If burst is soon expected, how can we invest boldly! Please clarify
    ( usually i could not add comment in any post, so i dont know this will be posted too)

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