The stock market has only one direction in mind and that’s up. I sense there’s froth building up. This current market action reminds me a bit of what happened in 1999, but the situation is different in that interest rates are at record lows, the Federal Reserve is providing liquidity, and the valuation of stocks is much more reasonable versus that of 1999.
My concern is how far the stock market can rise before we see a correction of any significant magnitude. Yet even with selling, it would be a buying opportunity, not a sign to exit.
The one key thing you need to make sure of is that your portfolio is diversified to withstand any major selling in a particular sector and market cap. Case in point: if you were heavily weighted in the precious metals, such as gold and silver, your portfolio would have been devastated by now.
This doesn’t mean you shouldn’t have any metals in your portfolio, but you need to have ample diversification, which is the key to success in the stock market.
If your assets are well diversified, it would be fine to play a possible upside bounce in gold. (Read “Is Gold’s Near-Beath Crisis Over-Exaggerated? Concerns of a Market Meltdown May Not Be.”)
The reality is that it doesn’t matter if you are investing in real estate, gold, stocks, art, or classic cars; the prudent way to protect your assets is to make sure you are diversified in the stock market.
The concept of spreading the investment risk is portfolio management—a process that encompasses the creation, monitoring, and adjustment of your investments. This process never stops, because you are continually buying and selling new stocks. Taking a portfolio approach to your stock market investments will help you improve your success.
When I refer to taking a “portfolio approach” to your stock market holdings, it means diversifying your investments through different industries. Not only do you need to spread your investment capital around a number of different stocks, but you also need to diversify your holdings across different industries. Owning a basket of stocks in one market sector increases your investment risk substantially, so you have to spread your money around different sectors if you want to protect your wealth over the long term.
Make sure you have investments spread across the board. The Dow Jones Industrial Average is a good index to look at as far as diversification ideas.
You can create a “do-it-yourself” fund by allocating your assets to various indices that will give you a broad measure of the stock market and allow for ample diversification. In this case, you can add a mixture of the Dow, S&P 500, NASDAQ, and Russell 2000 as the core holdings along with foreign exposure via exchange-traded funds (ETFs) in Asia, Latin America, and Europe.