I was engaged in a nice conversation with a new neighbor when I suddenly noticed, unbeknown to either of us, that my dog had lifted his leg and relieved himself on the neighbor’s shoe. The opportunity for a good first impression had been literally peed away. But equally important, it made me think about the things that we don’t really notice as life goes on around us.
Everything is rosy, right? The stock market has hit new highs, unemployment is heading down to multiyear lows, housing sales are bouncing back, and Minnesota will be hosting the Super Bowl. Life is good. All is calm.
That’s what I’m a little nervous about. In the financial planning business, this is the time to make several adjustments. When nothing seems to be going really wrong, you can hopefully make your required adjustments rationally. Here is your list to review.
Too much in stocks?
In John Cassidy’s book “How Markets Fail,’’ he describes economist Hyman Minsky’s view that “free-market capitalism is inherently unstable, and that the primary sources of this instability is the irresponsible actions of bankers, traders, and other financial types.” Minsky’s moments of instability tend to occur after prolonged periods of prosperity when people and entities ratchet up their risks.
Although the U.S. stock market is up more than 200 percent from the lows of 2009, prosperity has been elusive. This means you should disregard talks of a market meltdown, but don’t ignore the likelihood that we are going to be experiencing far more ups and downs with stock prices than we have over the past couple of years.
Virtually all asset classes have become more expensive. Investors are accepting greater risk for lower future returns. In order for U.S. stocks to provide strong prospective returns, the economy needs to continue to heat up, but not so rapidly that the Federal Reserve is forced to be parsimonious, causing interest rates to rise. This will be difficult for the Fed to get right.
But what should you do about it?
The best indicator of what stocks will do tomorrow is what they did yesterday. That’s because momentum is a decent predictor of future, short-term market movements. But over a longer period, the price you are paying for the earnings generated by companies — their valuation — is a much better indicator. So here is what you need to do:
• If you are planning on spending money in the next two years for tuition, housing expenses or cars, take your money out of stocks and put it into a safe instrument like federally insured online savings accounts.
• If you’ve been sitting on some cash that you are now ready to invest, don’t invest it all at once. Pick your diversified investment and put a little in each month or every time the markets fall by a certain percentage (say 3 percent). If the markets keep going up, you will have a little money working; if they fall, you will be buying at lower prices.
• Rebalance your 401(k) or retirement plans to the allocation you had intended before these markets reached their new highs. The point is to reduce some risk from your investments after these gains, not to sell them completely.
Wrong kind of debt?
If you haven’t been part of the refinancing boom on your home, jump on it. We are in a period where interest rates are low and will most likely stay there for a while, but this is a good time to look at your mortgage. Also, tie the length of the mortgage into the time you plan to be in the house. If you are confident that you will be moving in three to five years, consider a seven-year adjustable-rate mortgage. If you are sitting on unconstructive debt (credit cards or car loans), work on paying those down more quickly. It is enticing to use these low current rates to buy things that we can’t afford. Instead, take this period of calm to rework your cash flow, control your borrowing and pay down loans. If stock market returns are going to be compromised, paying off debt is a good investment.
This is not the time to get locked into areas that provide good income with little flexibility. Annuities may offer enticing initial yields, but they are much easier to buy than they are to sell. Most investments that are paying high income have a risk attached to them that is going unnoticed. Look at building up some cash reserves (or establishing lines of credit that you would only use in an emergency) to maximize your margins of safety.
There have been enough changes in tax laws to make it important to update your will. You also want to look at where your investments are located (retirement plans vs. taxable accounts) in order to maximize your after-tax returns and reduce some of your costs for Medicare. You want to be sure that your homeowner’s replacement coverage is adequate given the change in housing and building costs.
While I don’t believe that we are going to re-experience anything like 2008-2009, I do believe that things will not be as smooth going forward as they have been the past few years. If you’re prepared for the economic changes before they occur, you’ll be in a position to benefit from them. Use periods like this to make your mark rather than to be marked on.
Ross Levin is the founding principal of Accredited Investors Inc. in Edina. His Gains & Losses column appears twice monthly. His e-mail is firstname.lastname@example.org.