Despite a global pandemic that has led to countless job losses and much uncertainty, stock markets have once again reached new all-time highs. Although that has provided many investors cause for celebration, it has made others wary.
For some investors, it’s not easy to invest when stock markets hit new highs as they fear equities are at, or close to, a peak, and a crash could be on the way. However, the reality is investors will see new all-time highs on stock markets many times during their lifetimes.
Although predicting stock markets’ short-term performance is impossible, good financial advisors can help their clients by providing the following five recommendations during emotionally charged times when markets hit a new historical peak.
1. Accept that all-time highs are normal
Understanding that new record levels are not in any way odd occurrences that should make investors nervous is the first things advisors can do to help their clients.
The easiest way to explain this fact is by showing a chart of stock market returns since inception, illustrating that markets will go up over time, with new all-time highs along the way.
If clients need even more persuading, you can also show them the table below, which reveals just how many peaks the S&P/TSX Composite Index has reached since the 1970s.
2. Prepare yourself mentally
There’s an interesting parallel to be made between gambling and all-time highs on the stock market, and it relates to the gambler’s fallacy.
This concept describes the belief that the probability of a random event occurring in the future is influenced by previous instances of that same event.
For example, if someone goes to the casino, spins the roulette, and wins by betting the ball will land on red three times in a row, the brain will suggest that’s it’s too risky to bet on red again because it has just won so many times. The problem with that line of thinking is that previous spins of the roulette have no bearing on the result of the next spin.
The same can be said about stock markets reaching new highs. Many investors don’t want to invest when markets continue to produce gains because they’re worried the streak will stop.
However, if investors have a long-term view, that should not matter. Good advisors can help them realize that.
3. Look to historical events
As stock markets suffered massive declines after reaching all-time highs in 2000 and 2007, investors tend to associate these periods with terrible returns.
However, many people are surprised when they see the table below because, contrary to popular belief, the short-term returns of the MSCI World Index are higher when investing during all-time highs than during any other day.
Historically, all-time highs have been followed by even more record highs. Although timing the market is extremely difficult to do as stock market peaks only represent about 6 per cent of trading days, this information does reveal that these events are not necessarily followed by big drops.
4. Rebalance your portfolio
One time-tested approach to dealing with stocks reaching new highs is to rebalance clients’ portfolios. That strategy is one of the best ways to ensure that portfolios remain diversified over time.
Advisors will not always have an easy task when doing so as it means clients will need to accept you’re asking them to sell the asset classes that might have performed exceptionally well and buy the assets classes that have not.
Diversification leaves investors equally grateful and regretful, but it will increase the odds they stay invested over time.
5. Don’t wait for a correction
One of the most difficult things about investing is that there is always something to worry about. If investors don’t want to invest following a new all-time high, a great question an advisor could ask them is, “If not now, then when?”
If investors tell their advisor they’re waiting for a big correction, advisors can then provide some perspective. When stock markets crash, like they did last February and March, it often feels like the pain will never end. So, investors postpone their decision to invest yet again.
Market-timing simply doesn’t work, and one of the consequences is that investors who try to do that end up running out of time before they run out of money. All bear markets will be traced back to a peak, eventually, but that will only be known with the benefit of hindsight.
Jonathan Durocher is president of National Bank Financial Wealth Management.