Most investors buy stocks with the expectation that those stocks will rise in value over time. When that works out, those investors wind up with more money than they had before they invested. That's a good place to be, but only if they're able to make use of that cash.
After all, the stock market can be a fickle place. Money you thought you had one day can just as easily be gone the next, lost to the trends of the moment. Based on that reality, you need a plan for what you'd do if things go incredibly well for you in the market. With that in mind, here are four moves to make if the stock market skyrockets tomorrow.
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1. Recognize when you've reached "enough"
If you're investing for a purpose -- such as to cover your kids' educations -- you should have a reasonable estimate for how much you need to fulfil that purpose. If by skyrocketing, the market gets you to where you need to be ahead of when you need to be there -- congratulations, you've won the game. It's OK to stop playing. It's fine to take enough money out of the stock market to cover your intended purpose. You don't have to stop investing altogether, but why take risks you don't need to?
Yes, there's always the chance that the market could go up even further and put you ahead of your target. Remember, though, that there's also the chance the market could tank and take you away from a goal you had previously reached. By taking enough out to meet your goal, you will have done what you set out to do, and that's a victory you should recognize and enjoy.
2. Evaluate the value of your holdings
When all is said and done, a share of stock represents a fractional ownership stake in a company. Its price is based on whatever the market wants it to be at that time, but its real value is based on the company's future ability to generate cash over time.
While you won't be able to perfectly predict its cash generating ability, you don't have to get it perfect. With a reasonable estimate, you should be able to get a feel for whether the market's movement simply helped it reflect the true value of the business or whether its price now far exceeds that value.
Let that determination drive your decision on which investments to hold onto and which ones you're ready to part ways with. Consider selling the ones that look most overvalued based on your estimate. That way, even if the shares you sell happen to continue rising after you've sold them, you can at least be satisfied with the fact that you walked away with more cash in your pocket than you "should" have had.
3. Plan to enjoy a bit more of the good life
A solid guideline to follow is that money you expect to spend within the next five years does not belong in the stock market. If the market's actions mean you now have more than you need to cover your bare necessities, then it's perfectly OK to move more money out of stocks in order to increase your lifestyle.
Maybe you retire your car a little earlier than you had planned. Maybe you take a longer vacation or go to a more exotic destination. Maybe you fly first class instead of coach. Maybe you retire a little earlier or help your kids with some of their costs. Whatever you choose to do, enjoy it -- you've taken a risk that has paid off, and now you can reap the benefits of it.
4. Rebalance your holdings
Bond interest rates may be near all-time lows, but bonds still have a couple of advantages over stocks. First, they have better predictability of cash flows than stocks do, which is important if you're relying on your investments to cover your costs. Second, they are a higher priority in the financial pecking order than stocks are, so that you have a higher likelihood of getting paid if things go sour. Those factors mean there's still a place for well-chosen investment-grade bonds in your asset allocation plan.
Recognize that by moving some money from stocks to bonds, you're giving up some potential returns. You're also increasing the level of certainty in your portfolio and decreasing your exposure to future potential stock market crashes. The trade-off is certainly worth it if a market spike allows you to reach your goals faster than you originally thought you would.
It's all about finding the right balance
Although these four tips were centered around lightening up on your stock holdings due to the market skyrocketing, you can certainly keep money in the stock market for the longer term. The thing to remember is that investing is all about trade-offs and finding the right balance between the risks you're willing to take and the rewards you hope to see from those risks.
If the market offers you a gift, take it. The market's generosity doesn't last forever, and if you want to enjoy the money you've made from your investments, you need to take it as cash when it's being offered to you.
