February 1, 2013
After running in terror from stocks since the financial crisis, individuals are suddenly feeling cozy again about a stock market that's gained 120 percent since early 2009.
But should they?
In early January, investors threw a record amount of money — $55 billion — into stock mutual funds during a short period. It shows a change of heart, a more daring spirit, or perhaps a naive one. It's a reversal of the past few years when frightened investors pulled about $388 billion out of stock funds and poured about $1 trillion into bond funds.
This year's abrupt change toward investing is making some financial advisers nervous. Investors are notorious for picking the worst times to grow affectionate toward stocks. In 2000, they poured a record amount of money into stock funds just before the market plunged 49 percent as the technology sector crashed. In 2007, they threw billions into the stock market just in time for the 57 percent crash on the tails of the housing market collapse and global banking meltdown.
Each crash came when the stock market was near an all-time peak, which gave investors a sense of invincibility. They didn't realize that investing when stocks have climbed for a long time is more dangerous than when the stock market has plunged to terrifying depths. The market runs in cycles — dropping when stock prices have been pushed to expensive and precarious levels that can't last. Stocks recover when the masses have run in fear and bargain hunters show up to benefit from the sell-off.
In the months leading up to the 2000 and 2007 crashes, Americans were lulled into a false sense of security. With stocks soaring, more people than ever said they were confident about having enough money to retire when surveyed by the Employee Benefit Research Institute. Seventy-two percent were confident in 2000, and 70 percent in 2007. That year, 27 percent said they were "very confident." But inlast year's survey, only 14 percent were very confident they'd have enough money to retire.
Today, nervousness about the stock market seems to be dissipating after headlines have made individuals aware that they missed a 13.4 percent gain in the stock market last year and a 120 percent gain since March 2009. Instead, of being comforted by a 120 percent climb, though, investors should realize their "sense of timing has been way off," said financial planner Michael Kitces, of Columbia, Md.
"They sat out 100 percent of the bull market run," Kitces said. "If they didn't want to buy stocks when they were half price, why would they think they have it right to buy now? We are in a risky zone."
Kitces doesn't see any impending disaster but notes that the brightest economists and financial advisers rarely see red flags until the damage is done.
Individuals don't have to see an economic disaster coming to invest carefully, Kitces said. Instead, they need to know that cycles are always occurring in the stock market. When stocks have been climbing a long time and get pricey, they drop and leave people with losses. The drop isn't usually as sharp as in 2000 and 2007. But corrections — or downturns of 10 to 20 percent — are common at some point after investors have been infatuated with stocks for long stretches.
Consequently, Kitces suggests lightening up on stock funds during periods when stocks have been popular, and consequently pricey. He doesn't suggest bailing completely from stocks, but advises caution when the market provides an illusion of ever-climbing levels. Now, he suggests that because of pricey stocks and the 120 percent climb in the market, those who normally would invest 60 percent of their retirement savings in stocks and 40 percent in bonds, do the reverse — investing only 40 percent in stocks.
Financial planner William Bengen, of La Quinta, Calif., also suggests doing the opposite of what feels good. Given pricey stocks, he's had his clients keep their stock exposure at just 75 percent of what they'd normally do. If a correction occurs, and foreign stocks drop 10 percent, he will have his clients go bargain-hunting — adding cheap stocks through a diversified international fund.
Individuals with 401(k)s can make slow moves into and out of stocks with the new money they add each paycheck. That's better than jumping in with both feet when the water looks fine, or running in terror at the worst times.