Per my understanding of the Henssler model, ten-year money should be 100% invested under normal conditions. But with today’s P/E ratios higher than average, would it be prudent to go to 10% cash with the intention of re-investing it after the next 10% correction? I would raise the cash inside my IRA, eliminating taxable events. What do you think of this approach?
We adhere to the Ten Year Rule where money needed within the next 10 years should be in fixed-income investments to preserve principal. Money not needed in the next 10 years should be invested for growth.
So what is wrong with moving 10% of your portfolio to cash and investing it when the market drops? It is timing the market. Our current bull market has been about five years. It could easily last several more. The bull market from 1987 to 2000 was 13 years. You could be waiting a long time for that 10% correction. It could be within a year, or it could be several years. In that time, you would miss out on growth. If you are invested in dividend-paying stocks, you would miss out on that return as well. It is feasible by the time we have a 10% correction, stocks could be down to what they are selling for today.
Even if you were able to sell 10% of your portfolio today and reinvest after the 10% correction, the reality is investors tend to try to time the bottom. They wait to buy because stocks may drop another 5%. But as soon as they start to increase, you may have already missed your opportunity to buy. Timing the market is nearly impossible.
If you look at the 10-year average, the markets usually sell for around 16 times earnings. Today, stocks are selling for around 18 times earnings. However, we look beyond the historical average and consider where earnings are going. No one is predicting a recession. If anything, we predict some sloppy earnings growth to come. However, in those markets, corporations tend to earn more. Corporate value is based on the company’s earnings and the value investors place on those earnings.
Based on the Fed’s historical model, stocks should be selling for twice the price they are today. We do not feel the market is over valued. If there is outsized risk today, it is in long-term bonds, not high quality stocks. When interest rates increase 2%, yes the market will have a bit of a sell-off. Keep in mind during the 1987-2000 bull market there were many events that caused the market to drop, but nothing that caused a 20% correction.
However, if you want to go outside the lines with 10% of your portfolio, it probably won’t make a huge difference. You may lose money, but you may also be right, and you may make money. The Ten Year Rule is designed to prevent you from being forced to sell in a down market. Playing with 10% of your portfolio is just that. Selling when the market is down 30% because you’re scared is a poor decision, which the Ten Year Rule aims to prevent. If you have 10 years’ worth of liquidity, you shouldn’t be forced to sell. The market will likely recover in that time.
At Henssler Financial we believe you should Live Ready, and that includes understanding the risks when stepping outside of the Ten Year Rule. If you have questions regarding your financial situation, contact the Experts at Henssler Financial: