Personal Investor: Is it time to start trimming profits?
Investors who follow the golden rule of portfolio diversification are likely giddy in this market rally. But don’t let that giddiness let you fall into an old retail investor trap.
While the pros live the creed “buy low, sell high” DIYers tend to do the opposite. You might be tempted to buy into this rally when you really should be at least thinking of selling, or trimming profits.
Here are three reality checks from an informal poll of institutional investors:
Look at how valuations have changed. Has the difference between earnings and the price of the stock grown to a point where the price is not sustainable. The S&P 500 is currently trading at 22 times earnings compared with its historic average 16 times earnings. The pros say it depends on the sector and the stock but it is food for thought.
Another consideration comes down to portfolio diversification and rebalancing. As a stock outgrows other stocks it can hold too much sway in the performance of the overall portfolio. The pros say any single stock should not occupy more than five per cent of the portfolio unless there is an unusual case for a larger weighting. If you still like the stock consider trimming it back.
Some institutional money managers say you should not do any selling in this market unless the cash is going to be deployed in another investment. They say it’s better to earn three per cent on a dividend stock than zero in cash. On the other hand, some institutional investors say it’s a great time to go to cash because it’s relative value will gain if markets go down, and there are bargains to be had.