As the Toronto Stock Exchange (TSX) breaks record highs, it’s crucial for investors to reassess their strategies. While the excitement of a booming market can be enticing, taking deliberate steps with your investments now can help protect and optimize your portfolio. Here are three essential strategies to consider as the TSX soars.
Don’t be swayed by market euphoria
In times of market euphoria, it’s easy to get swept up in the enthusiasm. However, this excitement can lead you to chase stocks that may be overvalued. It’s vital to remember that fluctuations in growth expectations can significantly affect stock valuations. A drastic change in the growth outlook can lead to a substantial re-rate, in either direction.
For instance, the recent surge in artificial intelligence (AI) stocks has generated immense interest, with companies like Super Micro Computer (NASDAQ:SMCI) capturing headlines. While these stocks offer exciting wealth creation potential, their volatility should not be overlooked. You need to conduct thorough due diligence and assess the risks before diving in. Understanding the fundamentals of the stocks you’re considering can help you avoid costly mistakes in an overheated market.
Reassess and re-balance your portfolio
As market conditions change, portfolio re-balancing becomes a key strategy for maintaining balance and mitigating risk. Review your holdings to determine if any stocks have surged in price and may now be overvalued. Many fund managers adhere to strict position allocation rules to prevent any single stock from dominating their portfolio, thus reducing the risk of significant reduction in wealth.
Conversely, a buy-and-hold strategy can also be successful, provided you invest in quality businesses that generate consistent profits. For example, if you’d purchased shares of Royal Bank of Canada (TSX:RY) at around $111 per share with a 4.9% yield in October 2023, you would be enjoying impressive gains of about 51%, while having pocketed tasty dividends.
However, with the stock’s price-to-earnings ratio stretching to around 14, it may be wise to take some profits and explore new opportunities. If RBC constitutes a small portion of your portfolio, holding onto it could be a valid choice. You can then consider adding to your position at a lower valuation in the future.
Evaluate your cash position
In a rising market, the phrase “cash is king” can take on a different meaning. While cash reserves provide flexibility during downturns, they can also represent missed opportunities when the market is climbing. Keeping cash on the sidelines yields minimal returns compared to the potential gains available from equity investments.
As the TSX reaches new heights, some fund managers opt to maintain a cash position of 10-30% to hedge against potential downturns. It’s important to evaluate your own comfort level with cash holdings during these times. Consider the opportunity cost of not investing versus the inherent risks of a market correction, which historically follows periods of strong performance.
If you decide to stay invested to capitalize on long-term growth, approach new investments with care. Focus on selecting stocks with strong fundamentals and reasonable valuations, and ensure that your investment strategy aligns with your financial goals and risk tolerance.
The Foolish investor takeaway
Navigating a record-high market requires a balanced approach. By resisting market euphoria, re-balancing your portfolio, and carefully evaluating your cash position, you can position yourself for sustained success. Keeping a level head amid the excitement can help protect your investments and set the stage for future growth.