Worried about the stock market? Congratulations!
When you see the downside risks, you get a better sense of whether your current mix of stocks, bonds and cash is the right one.
A lot of market commentary implies that investors should be either all-in stocks, or all-out – but the best approach is far more nuanced.
For example, perhaps rebalancing is all you need. If you had a 60-per-cent allocation to stocks at the start of the bull market in 2009, and you haven't shifted the allocation, chances are that your exposure to stocks is now much higher – making a stock market downturn more painful.
All you have to do is sell some of your stocks to get back to your ideal mix. Bonds, GICs and cash will provide a nice buffer if things go wrong, and a good source of money if better buying opportunities arise in the stock market.
You can also examine your stocks to see whether they are tilted toward a booming economy or a more subdued future. During the bull market, consumer discretionary stocks, financials and industrials have led the way, with gains of more than 250 per cent.
Some individual stocks have unusually high valuations, implying big growth opportunities, but also a high level of risk should something go wrong. Tesla Motors Inc. trades at 235-times estimated earnings.
But cautious investors tend to prefer less exciting areas of the market, such as slow-growing multinationals and telecom stocks, that offer bullet-proof dividends and better protection from disappointing economic activity and market selloffs.
Fifty-four stocks in the S&P 500 are considered dividend aristocrats, raising their dividends every year for at least 25 years. They include Bard C.R. Inc., Sherwin-Williams Co. and Air Products & Chemicals Inc.
Canada has its aristocrats, too, though qualifications are easier to meet: Sixty-five companies in the S&P/TSX composite index have raised their dividends every year for at least five years. They include BCE Inc., Emera Inc. and IGM Financial Inc.
You can also explore markets that appear less frothy than North America. Despite an impressive recovery over the past two years, European stocks remain 30 per cent below their 2007 highs. Emerging market stocks have been moving sideways for most of the past three years.
Boston-based global asset manager GMO LLC regularly publishes its forecasts for the next seven years. Currently, they see outright losses for U.S. large-capitalization and small-cap stocks, slim gains for international stocks, and modest gains for high-quality U.S. stocks with low debt and stable earnings. But they put emerging-market stocks on top, with expected annual returns of 3.4 per cent.