Was the fourth quarter of 2018 just a bad dream for investors? It sure looks like it now.
The S&P 500 closed out the first four months of the year with its best results in 32 years (1987). It has also rallied more than 20 percent from the December lows, and recently bested its previous all-time high. That's quite a turnaround from the nastiest December since 1931 and the worst annual performance for U.S. stocks (S&P 500 was down 6.2 percent in 2018) since the 2008 financial crisis.
At the end of last year, I attempted to help guard against your worst fear-based actions by creating an investor panic prevention plan. Now, as indexes take out their previous high water marks, it's time to activate the investor greed prevention plan.
Step 1: Remind yourself why you are investing. This was Step 1 of the panic plan, and it is equally useful now. Just because stocks have roared back in the first four months of the year does not mean that you should be hooting, hollering and high-fiving. In fact, now would be an ideal time to determine whether you are on track to meet your long-term goals (you have those, right?), such as retirement or college.
When projecting future returns on your investments, don't go crazy. Instead, try to identify the lowest rate of return necessary to reach those goals.
Step 2: Rebalance (or get into balance). Stock market records are the perfect time to check in on (or create) your asset allocation plan. Be careful not to fall prey to your greed, which may induce you to assume more risk in your portfolio than you can truly stomach. As many learned the hard way, we may feel a bit bolder when markets are moving higher, only to regret it later when stock market indexes plummet.
One of the best ways to prevent emotional swings is to create and adhere to a diversified portfolio that spreads out your risk across different asset classes, such as stocks, bonds, cash and commodities. As one successful hedge fund manager recently told me, "In life — and in markets — there are always banana peels. You never know when you are going to step on one and fall on your face."
And when you do slip and fall on that banana peel, you will be very happy to have built in some safety into your portfolio.
Step 3: Replenish your emergency reserve fund. Did an unforeseen tax bill force you to dip into your emergency reserves? If you have a non-retirement investment account or company stock, this could be a good opportunity to replenish it. Remember, you are trying to maintain six to twelve months of expenses (for those who are employed) and 12 to 24 months of expenses for those who are already retired.
While you are at it, be sure to set aside any funds that you might need within the next 12 months, including a home down payment, a new car or a tuition bill.
Step 4: Don't confuse market returns with your intelligence. Rising markets can lead some to believe that they have a magic touch, but that may be overstating your abilities.
Some of us tend to think we are the incarnation of Warren Buffett when the bull is running, but the real test is whether you can handle the pressure when the bear comes out to eat your lunch.