Prudence Amid Prosperity

05/01/2007 12:00 am EST

Focus: MARKETS

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

Gordon Pape, publisher of Internet Wealth Builder and The Income Investor, says as the markets hit record levels, a little caution is advisable, since what goes up must eventually come down.

There's nothing like a new record high on the stock market to make an investor's day. That's why there was such exuberance last week after the Dow Jones Industrial Average cracked through the 13,000 mark to [achieve] an all-time closing high.

The encouraging thing about the performance of the Dow, as well as the Standard & Poor's 500, which is just short of its all-time high, is that this bull market is broadly based.  It's also worth noting that US stocks have continued to do well despite the weakness in real estate.

While new market tops are exciting, especially if your own stocks are doing well, they should also be sobering. In the financial world, what goes up inevitably goes down, at least temporarily. The wise investor always prepares for a downturn in advance. Here are some tips on how to do that.

Maintain portfolio balance. Balance is the best protection against a stock market correction. During the 2000-2002 bear market, portfolios that included a decent bond weighting (I recommend 30%+) held up reasonably well and the higher the bond component, the less the damage sustained.

Review your assets more frequently. Usually I suggest a thorough portfolio review at least once a quarter. However, in the current circumstances a monthly review is more advisable. Look especially for stocks that are showing good capital gains and which may be losing momentum. They offer good opportunities for profit-taking and rebalancing.

Be cautious about new purchases. Although we continue to recommend new stocks, we are doing so in the context of a relatively expensive market. If your portfolio is already fully weighted in equities and there is nothing you want to sell right now, I suggest you make a note of the new stocks that interest you and track them. When the time comes to take profits on an existing position, choose one from your list to replace it with.

Keep an eye on inflation. Although the Bank of Canada left its key overnight rate untouched last week, the concern it expressed about inflationary pressures should not be forgotten. The BoC's comments echoed those of the Open Market Committee of the US Federal Reserve Board at the close of its March 20-21 meeting.

The Fed meets again on May 9 against the backdrop of a strong stock market and rapidly rising gasoline prices, which have broken through the $4.00-a-gallon level in some parts of California. If the Fed should return to a tightening policy and raise rates, it would bring this market run to a screeching halt, so be wary.

Remember the old stock market adage, "sell in May and go away"? I'm not suggesting you need to do anything quite that drastic, but certainly a little house cleaning and perhaps some selected profit-taking might not be a bad idea in the circumstances.

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