Special to the Globe and Mail
Published September 23, 2014

By Tom Bradley

So much of my communication with clients – and my columns in The Globe – focuses on investor behaviour during bear markets. Don’t panic. Stick to the plan. Take advantage of sale prices. (Re)read Warren Buffett and watch what he does.

For sure, the down part of any market cycle is when the biggest mistakes are made. The meltdown in 2008-09 provided ample evidence of this. But managing a portfolio with a steady hand is not a one-sided exercise. Bull markets also require discipline, patience and fortitude. The tech boom of the late nineties should have forever taught us that.

"For sure, the down part of any market cycle is when the biggest mistakes are made"

Before I go on, I want to reinforce that I don’t try to be too precise in determining where we are in the market cycle. As esteemed economist John Kenneth Galbraith said, “We have two classes of forecaster: Those who don’t know and those who don’t know they don’t know.”

I think it’s fair to say, however, that after five years of excellent returns, it’s appropriate to focus on the bull side of the equation. Valuations on bonds and stocks are perceptively higher today (and arguably getting stretched), and I would describe investor sentiment as more complacent than fearful.

It’s been a fun market and it may go on for a while, but investors don’t get to take a holiday. With the sizable market moves, their portfolios need more attention, not less.

To help bring some even-handedness to your process, here’s an exercise I urge you to try. Take a look at the asset mix of your current portfolio – all your financial assets combined. Calculate an approximate percentage for your equity/fixed income mix (precision is not important here). Then make a quick assessment of your fixed income investments. Where are they on the spectrum of simple versus complex? Are they low risk, or are they seeking equity-like returns?

Now, the most important (and difficult) part: go back in your files and do the same thing for your portfolio for either 2010, 2011, or even 2012.

The point of the exercise is to give yourself a reality check:

  • Does your portfolio have more equity content now?
  • Are your stable investments riskier than they used to be? Instead of GICs and government bond ladders, are you invested in products with “high yield,” “leveraged” and “enhanced income” in the name?
  • Even though you’re four or five years older, are you more comfortable with a “growthier” portfolio, and are you asking yourself if you need to be more aggressive?
  • And are you less worried about negative returns today, or don’t even think about it much?

If you answered “Yes” to most or all of these questions, then you’re running with more risk than your plan calls for. There could be good reasons why this is the case. Your circumstances may have changed, or the previous mix was too conservative for your situation.

Other reasons for a more aggressive tilt are less sound. Five years of rising markets has increased your risk tolerance and now you’re more comfortable with long-term investing. Or even worse, returns have been good and you want more. It’s time to make up for lost ground.

Recent returns are not a good predictor of future returns, and are a poor reason to deviate from your long-term plan. Looking in the rear-view mirror pushed investors to overinvest in the late nineties and kept many out of the market in 2009 and beyond.

We’re again at a point in the cycle – call it the “comfort zone”– when there’s an increasing chance that investors will stray from their long-term plans. It’s easy to let things run. But while it feels good, it makes little sense to be more aggressive at a time when the potential reward for taking risk has been significantly reduced.

Mr. Galbraith reminds us that we don’t know where markets are going in the short term, but we can still try to put the odds in our favour. In my view, valuations based on fundamentals and history are telling us to lean toward caution, not aggression. And for sure, they’re telling us to pay attention to our portfolios with the same intensity as we do in bear markets.