Hi VirtueRunsDeep,
Congratulations for being long the current equity market.
I assume that you trust your existing portfolio; that you are reasonably satisfied that you made both a prudent asset allocation and wise choices within each category.
It is important to remember that you should have a definitive, well-grounded reason to sell. The evidence is overwhelming that individual investors make poor timing and product selection decisions. We underperform the funds we buy because of poorly timed entry/exit decisions, and we frequently sell holdings that subsequently outperform our replacement positions. Be very, very careful when planning a sell.
The sell decision is likely the most difficult that confronts and confuses just about every investor, even when only contemplating a partial portfolio downsizing. Anxiety escalates. Of course, that’s not the case with market speculators (frequent traders, gamblers). This disparity highlights the need to know what type of investor each of us really is.
We investors typically overreact. That’s partly why the marketplace in never quite in equilibrium, why we merely approach total efficiency, and why shrewd Operators (Warren Buffett, Ed Thorp, some Hedge Fund managers) gain excess returns. A few Guys just have more resources and better instincts in how to play the money game. For most of us, it’s a constant struggle.
A couple of days ago, MFO’s researcher Ted posted a Link that summarized the investment wisdom of several prominent market wizards. The distinguished Sir John Templeton was among that group. Several of his rules are especially relevant to your question.
Sir John said: “1. Invest for maximum total real return”. That maxim essentially translates into a maximize Geometric (compound) return rule after adjustments for inflation and return volatility (standard deviation).
A very close approximate equation that translates average annual return into Geometric annual return is simply the average yearly return minus one-half times the square of its standard deviation. Geometric return is always less than its average value.
As Einstein observed, compounding is a most powerful magical ingredient. So in many circumstances, permitting a winning investment to ride, to compound, is a competitive strategy if maximum returns are a goal. Yes, that increases portfolio volatility, but it maximizes end wealth. It requires a strong risk tolerance constitution, a commitment to the plan, and adequate reserves to survive the guaranteed bumpy ride. Diversification helps smooth that ride. That’s why Templeton noted: “7. Diversify. In stocks and bonds, as in much else, there is safety in numbers” and “15. There’s no free lunch”.
Sir John’s last admonition is most pertinent to your quandary. He said: “16. Do not be fearful or negative too often”. We all do tend to worry far too much. There is indeed a delicate balance between being too conservative and too aggressive.
Admittedly, in gambler’s parlance, both under-betting and over-betting can be hazardous to end wealth and happiness. Since future market rewards are an unknowable uncertainty, your tactic of making incremental portfolio adjustments is prudent. I too have adopted that risk management policy.
Nobody presciently forecasts future market rewards with any persistence. A recent Forbes article addressed that issue convincingly as follows:
http://www.forbes.com/sites/rickferri/2013/01/10/ts-official-gurus-cant-accurately-predict-markets/Thousands of experts have attempted to predict market tops; thousands have failed. The marketplace has far too many interactive parts; its topography is far too complex for precise projections. But some metrics might be useful to serve as guides. The metrics likely should include contributions from macroeconomics, microeconomics, momentum effects, government policies, and investor sentiments. It would be an imposing array of numbers that would require sophisticated analyses, likely on computers.
That task is too burdensome for the private investor, but not so for institutional agencies. Models using scores and scores of input parameters are fed into institutional computer programs on a daily basis. It is not clear that all this expertise and modeling have significantly improved our composite forecasting accuracy. We still can not reliably predict market reversals or economic recessions. But some signals can be useful to provide some generic, not fully accurate, guidance. False signals seem to be a persistent residual in all analytical methods.
Unless you want to be a slave to the marketplace, I suggest you limit your monitoring of these signals to a small number that you can easily access.
For those purposes, to gauge market momentum I use a variant of the standard Simple Moving Average (SMA) statistic. I examine the relative positioning of the 65-day and the 200-day S&P 500 SMAs that the WSJ report every Monday.
To gauge overall market valuation, I simply review the S&P 500 Index’s Price-to-Earnings ratio (P/E) also found in that same WSJ chart. I am very sanguine when its value is below 15; I am still in my comfort zone when it escalates into the twenty range. I become increasing troubled when the P/E ratio penetrates the 30 level. That’s an overheated marketplace.
Profits are tightly correlated to GDP and GDP per person growth rate. For a developed economy like the US, a healthy value like 3 or above is great for stocks. In the US, GDP is mostly dependent upon two factors: one-third on population growth and two-thirds on productivity enhancements. Since population increases at about 1 % per year, a level of GDP per person growth rate of 2 % is needed. So monitor GDP data. We are presently slightly below that goal, but are moving in the correct direction. I am guardedly optimistic.
Inflation is bad for both the bond market and, in the short-term, for the stock market. Today, it remains at an attractive level. The long range prospects are not encouraging since the government printing of money weakens the dollar without producing actual real goods to absorb the flood of money. Inflation is a long range threat.
The behavioral economists have identified sentiment as a key market contributor. I use the AAII investor sentiment index as a rough inverse measurement of the overall populations investment feelings. A high relative number is bad news since it portends an over zealous investor cohort. It is readily available at the following website:
http://www.aaii.com/sentimentsurveyIt is currently slightly above its historic average and moving still higher. That’s a cautionary signal since it is useful as a contrarians indicator.
I do use a few other metrics to serve as a guide to my investment decision making, but if I am not yet boring you, I am boring myself.
I do hope this gets you thinking to select a few statistical parameters to inform your decision making. All of these are imperfect inputs into an uncertain decision. I recognize that some signals will be positive while others will be negative. Mixed outcomes are the rule, not the exception; they hardly ever all point in the same direction. I have no formula to resolve this dilemma. Unfortunately, intuition, experience, and heuristics must now be deployed.
That’s the way the marketplace resembles gambling. There are many similarities to both processes. With the application of a few rules and solid money management discipline, you can improve the odds of a fat
retirement portfolio.
Others at MFO have done so; so can you. I like many of the suggestions that earlier responders have contributed. It’s up to you to assemble a coherent plan from them. It’s doable.
Good luck, especially since that’s an important factor in all investing.
Best Regards.
