Cashing in your chips could be a big mistake with the Dow and S&P 500 hitting new highs.
This has been an extraordinary year for stocks, and it just seems to get weirder by the minute.
After beginning with the worst two-week start in recorded history, and subsequently witnessing all three indexes tumble more than 10% from their Dec. 31, 2015 close by mid-February, the broad-based S&P 500 (SNPINDEX:^GSPC) wound up staging its largest intra-quarter rally in 83 years to finish the first quarter slightly higher. More recently, Brexit sent the U.S. stock market into a quick, but dizzying spiral lower. Just weeks later we’re now racking up new all-time highs on the Dow Jones Industrial Average and S&P 500.
This recent volatility and global uncertainty may have left you wondering what to do next as an investor. Here are four things you should consider doing right now.
1. Be patient and stay the course
The first thing you should be doing is not overreact by clicking the “sell” button in your brokerage account just because a few stocks in your portfolio may be hitting new highs. Emotions are a two-way street, and just as we’re tempted to run for the hills when the stock market is tumbling, we need to remember not to cash in our chips just because the stock market is rising. Remember, stock market valuations, as a whole, have a tendency to rise over the long term. A rising market is a great thing. Sit back and enjoy the ride if the investment thesis behind the stocks you’ve bought hasn’t changed.
Plus, holding your stocks for the long term (366 days or more) means paying the considerably lower long-term capital gains tax rate as opposed to ordinary income tax rates associated with short-term asset sales. For those of you in the 10% and 15% ordinary income tax brackets, your long-term capital gains tax rate is 0%.
2. Keep buying regularly
Second, consider adding to your investment portfolio even with the stock market at or near its all-time high. Though it might seem counterintuitive to buy now, if you’re buying high-quality companies for the long term, it should work out in your favor for two key reasons.
To begin with, adding money to your investment portfolio and regularly buying stocks allows you to dollar-cost average into your holdings. This should, over a long period of time, help you achieve a relatively attractive cost basis on the companies in your portfolio while reducing the emotional aspect of trying to “time the market,” which is practically impossible to do over the long run.
But, more importantly, history says that if you buy regularly and are patient, you should make money over the long run. Since 1950, according to Yardeni Research, the S&P 500 has undergone 35 corrections of at least 10%, when rounded to the nearest integer. In every single one of those instances, the stock market put these losses in the rearview mirror within weeks, months, or (in rarer cases) years. Even if you bought at stock market peaks and regularly dollar-cost averaged throughout corrections, history suggests you’ll probably turn a profit. While past returns are certainly no guarantee of future results, a 35-for-35 record since 1950 pretty decisively favors long-term investors.
3. Add dividend stocks for peace of mind
If you worry about a stock market downturn, think about adding dividend-paying stocks to your portfolio. Dividend stocks provide a number of benefits that can reduce the emotional aspects of investing, improve your real wealth creation, and perhaps even lower the volatility your portfolio experiences during stock market corrections.
As you can imagine, only companies with a proven business model and solid growth outlook are liable to pay a dividend. This means a dividend payment is often an advertisement or beacon for income investors looking for solid companies. Also, since dividend-paying companies typically have proven business models, they may also be less likely to fall substantially during a stock market correction, which can potentially reduce the volatility your investment portfolio experiences.
In addition to the payout received, which can hedge against a downward move in the market, dividends can also be reinvested back into more shares of dividend-paying stock. This process, which is known as compounding, allows you to grow both the number of shares of stock you own, as well as the payout you’ll receive. Over time, it can be a lucrative strategy to generate substantial wealth.
4. Consider growth stocks
Finally, you might want to add growth stocks to your investment portfolio if you find that your tolerance for risk is a bit higher and you’re less prone to being influenced by your emotions.
According to a recently released study from Bank of America/Merrill Lynch, both value stocks and growth stocks have delivered incredible annual returns over the past 90 years of 17% and 12.6%, respectively. Although value stocks have outperformed over this nine-decade period, growth stocks have trumped value since the Great Recession. The unique dynamic of persistently low lending rates could give growth stocks an edge by providing access to cheap and bountiful capital that can be used for hiring, business expansion, and acquisitions.
Individual growth stocks or exchange-traded funds (ETFs) could be smart options for the long-term investor to consider with the stock market hitting new highs.
A rising stock market is no reason to change your game plan. If anything, it demonstrates that the long-term investors’ game plan works.
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