The greed factor is growing among American investors and that makes me nervous.
The Wall Street Journal reported last week that there has been a significant drop in the purchase of put options in New York.
That means fewer people are taking out "insurance policies" against a sudden drop in stock prices. Put options allow you to sell a security at a specific price up to the expiry date. So if the market drops, your downside is limited.
With stocks continuing to rise at a rapid rate, more investors are apparently viewing the cost of this "insurance" as a waste of money. They will feel much differently if things go sour.
Of course, most investors have never traded in put options. But you may be increasing your portfolio risk in other ways and perhaps you need some different types of insurance. Ask yourself these five questions.
Am I still comfortable with my asset mix? Your asset allocation (the percentages allocated to stocks, bonds, and cash in your portfolio) is the number one determinant of your risk level. I have said this repeatedly in the past but I can't repeat it often enough. The greater the proportion of stocks you own, the more vulnerable you are. Know what your current allocation is and be sure you can live with it if things go bad.
Is my portfolio overloaded with high-priced stocks? Many investors have made a lot of money in the past few years, especially in the tech sector. We haven't yet reached the point of a tech bubble, as I pointed out last week, but if prices keep rising at this pace we'll get there. Check the valuations of the companies you own, starting with basic price/earnings ratios. If any stocks are getting out of line, consider taking some profits.
Have I let my bond holdings run down? Nobody wants to own bonds these days. With interest rates on the rise, bond prices are being depressed. Moreover, if current trends continue we could be in for a fairly lengthy cycle of rate increases. That makes investors even more wary. But bonds act as a stabilizer when stock prices retreat. They may not earn much now but you'll be happy to own them if the market goes south.
Do I have some cash to take deploy if a pullback occurs? Do you wait for sales to buy big-ticket items like TV sets? If so, you should apply the same philosophy to stocks. A market correction is the best time to buy quality companies. Believe it or not, 10 years ago in the depths of the Great Recession you could have purchased shares in Bank of Montreal for about $28 with a yield of over 11 per cent. The shares closed last week at $102.42.
Am I properly diversified? Jeff Weniger, asset allocation strategist at WisdomTree Asset Management, said in a recent interview that he believes the best values this year are to be found in Asia, Europe, and the emerging markets. Check your portfolio to see how much you have invested in these areas. Chances are it is not enough. If that's the case, consider taking some profits in your North American stocks and reinvesting the money overseas.
I do not expect a return to a bear market any time soon. But not having some insurance to protect against the unexpected is foolhardy. It's like cancelling your home insurance and hoping a fire doesn't break out tomorrow.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to Www.buildingwealth.ca. Follow Gordon Pape on Twitter at twitter.com/GPUpdates and on Facebook at www.facebook.com/GordonPapeMoney