Beware: Markets Are Up

Right now, as the brouhaha in Washington recedes, economic indicators improve and some key companies churn out better-than-expected earnings, stocks are near record highs. But don’t make the mistake of buying at the top.

The Dow Jones Industrial Average closed Friday at 14,009.79, near the Oct. 9, 2007 market peak of 14,164.53. This means the Dow is now within 154.74 points of that record high. That is cause for celebration, right? Is it time to take on more risk?

Not to be a killjoy, but if you are using all-time market highs as a signal to get more aggressive or to buy more stocks, you might have missed the party already.

This is not to say stop investing. I’m simply saying that, when prices are higher, your money buys less than when prices are lower. Investors behavior tracks what I call the Cycle of Market Emotions: When emotions are the most jubilant, the markets are at most risk of taking back what they have given.

As legendary investor Warren Buffett so famously wrote in a New York Times op-ed piece in October 2008, at the worst of the financial crisis: “Be fearful when others are greedy, and be greedy when others are fearful.” Buying at the top is a surefire way to go broke.

Emotionally and numerically, we are now at the opposite end of the market from when the Dow was at its nadir of 6547.05 on March 9, 2009. Then, we all felt the worst about our net worth and portfolio values. But that was precisely when risk was at its lowest.

Of course, we didn’t know this until we had the luxury of hindsight. That was the time to buy. In late 2008, Buffett loaded up on stocks while the whole financial system fell apart.

Of course, the bullish spirit might still prevail. According to the Stock Trader’s Almanac, January is a good predictor for the rest of the year. A good start like January’s 5.8% rally in the Dow usually portends a good year for stocks.

To be sure, this predictor always works except when it doesn’t, like in 2001, when the dot-com bust dragged on the market. Still, there are investors that might call a top and sell stocks or exercise options to lock in gains.

The moral of the story is that our emotions are often at polar opposites of what the true risk is when it comes to markets. It’s far from easy to tell yourself to buy stocks at the bottom when the headlines are all scary – and also to hold off when things are looking sunny. Feeling this way is perfectly natural.

 It helps to have a financial advisor in your corner to tell you to be fearful and greedy at the right times.

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Larry R Frank Sr., CFP, is a Registered Investment Adviser (California) in Roseville, Calif. He is the author of the book, Wealth Odyssey. He has an MBA with a finance concentration and B.S. cum laude in physics with which he views the world of money dynamically. He has peer-reviewed research published in the Journal of Financial Planning.

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