Almost everything in your 401(k) should be coming up a winner now. That makes it time for a gut check.
Not only is the U.S. stock market setting records, so are foreign stocks. Bond funds, which are supposed to be the boring and safe part of any portfolio, are also doing well this year, along with gold and cryptocurrencies.
Many professionals along Wall Street are forecasting that the U.S. stock market will keep rising. But the threat of a sharp drop remains, as it always does. That leaves investors with the luxury now, while prices are high, to reassess. Don’t get lulled into leaving your 401(k) on autopilot, unless you’re intentionally doing so, and make sure your portfolio isn’t stuffed with too much risk.
Here are some things to keep in mind:
The stock market is doing well?
Even after a few recent stumbles, the S&P 500 has soared more than 35% from its low point in April, shortly after “Liberation Day.”
“The market continues to (hit) record highs on the back of strong earnings and easing U.S.–China trade tensions,” said Mark Hackett, chief market strategist at Nationwide, who calls the current state of “steady growth without irrational exuberance” a ”Goldilocks environment.”
If the market’s so great, why should I worry?
You don’t need to worry at the moment, but remember that the stock market will fall eventually. It always does.
The S&P 500 index, which sits at the heart of many 401(k) accounts, has forced investors to swallow a 10% drop every couple of years or so, on average. That’s what Wall Street calls a “correction,” and professional investors see them as ways to clear out excessive optimism that may have pushed prices too high.
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More serious drops of at least 20%, which Wall Street calls “bear markets,” are less common but can last for years.
Back in April, the S&P 500 index plunged nearly 20% from its record at the time. But the market came back, propelled by the big tech companies that have led the way the last few years.
What could trip up the market?
The stock market has charged to records because investors are expecting several important things to happen. If any fail to pan out, it would undercut the market.
Chief among those expectations is that big U.S. companies will continue to deliver big growth in profits. That’s one of the few ways they can justify the jumps in their stock prices and quiet criticism that they’ve become too expensive. One popular measure of valuing stocks, which looks at corporate profits over the preceding 10 years, showed the S&P 500 recently was near its most expensive level since the 2000 dot-com bubble.
Consider Nvidia, the chip company that’s become the poster child of the artificial-intelligence trade. If it fails to meet analysts’ high expectations for growth, its stock will look more expensive than it already does. It’s trading at 54 times its earnings per share over the last 12 months, much higher than the overall S&P 500’s price-earnings ratio of nearly 30.
What’s the next event to be mindful of?
Wednesday’s meeting of the Federal Reserve could be a key moment for the market.
Besides companies delivering bigger profits or stock prices falling, another way for the stock market to look less expensive is if interest rates ease.
The widespread expectation is that the Fed will cut its main interest rate. Investors will focus will be on whether the Fed gives any hints about the likelihood of more cuts in coming months.
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Several of Wall Street’s most influential companies will report earnings this week, including Microsoft and Apple. And President Donald Trump will be meeting with China’s leader, Xi Jinping on Thursday.
If there’s a bubble, I should sell everything, right?
A famous saying on Wall Street is that being too early is the same as being wrong.
The best approach might be: Make sure your investments are set up the right way, so you can stomach the market whether it goes up or down.
How much of my 401(k) should be in stocks?
It depends on your age and how much risk you’re willing to take.
If you did sell stocks this past April, you may have had too much of your portfolio in stocks for your risk tolerance. Or you may need to steel yourself more during the next drop.
Remember that anyone decades away from retirement has the luxury of waiting out any drops in the market. Bear markets are actually great in that case, because they put stocks on sale for anyone continuing to make regular contributions to their 401(k).
Workers closer to retirement still need stocks, though in smaller proportions, because they have historically provided the highest returns over the long term, and a retirement can last decades.
I hate all this uncertainty
Unfortunately, it’s the price you have to pay if you want the strong returns that the U.S. stock market has historically provided over the long term.
This is what the stock market does. It goes up and down, sometimes by shocking amounts, but it usually helps patient savers build their nest eggs over decades.
Ben Fulton, CEO of WEBs investments, recommends monitoring volatility by paying attention to the VIX, a volatility index, sometimes called the “fear index, which measures market expectations of future risk. The VIX is currently around 16, which Fulton said signals ”calm by historical standards.”
However, if the VIX holds steady above 20, it often “signals a time to gradually reduce market exposure,” he said.