Since the start of 2023, the Nasdaq Composite is up a blistering 72%, while the S&P 500 has achieved an impressive 45% gain. Some investors may feel that the market is overextended.
Aside from many stocks fetching higher than historical valuations, there are plenty of economic indicators -- from U.S. money supply to the state of the housing market and the consumer -- that indicate the market could be poised for a sell-off or even a correction.
Here are three mistakes to avoid in the second half of 2024 and how you can prepare for whatever the market brings for the rest of the year.
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1. Overhauling your portfolio
One of the worst decisions you can make is changing your investing strategy and portfolio based on emotion. Even if the stock market sells off, history shows that holding through periods of volatility is a winning strategy. The Nasdaq Composite and S&P 500 suffered brutal downturns in 2022. But in the time since then, both indexes have more than made up for those losses.
Even if an investor had a crystal ball and knew the market was going to sell off, it still would have been better to endure the downturn rather than sell and never get back in. The reason why timing the market is a bad idea is that you have to be right twice -- knowing when to sell and when to buy. On the other hand, buying and holding quality companies requires only one good decision.
Now is a good time to conduct a portfolio review and make sure your investments align with your risk tolerance. When a certain sector or theme drastically outperforms others, it can completely change the allocation of a portfolio. For example, if you owned even a small position in stocks like Nvidia or Meta Platforms that have increased several-fold over a relatively short amount of time, those companies would likely have become much larger positions on a percentage basis.
Of course, you could trim the position to reduce the weighting. But another solution is to shift the way that you allocate new capital. Investors who regularly contribute new savings to their portfolios can simply put those contributions to work in completely different companies. For example, if you feel you have too much exposure to tech stocks, maybe consider another sector. You could also explore an exchange-traded fund (ETF) that provides diversification across many different companies.
In sum, there is a clear difference between reconstructing a portfolio and making some adjustments. The key is to be comfortable, and the best way to achieve comfortability is to know what you own and why you own it. You should also make sure your portfolio doesn't have more risk than you'd like.
2. Chasing hot stocks
We just discussed how allocation can change based on owning winning stocks that now make up a larger percentage of the portfolio. It's a good problem to have. But then there's the exact opposite scenario.
It would be very hard to have kept pace with the major indexes since the start of 2023 if you didn't own mega-cap growth stocks. There have been plenty of outperforming companies in every sector. But in general, the tech and communications sectors have led the market rally.
It's a good idea to make sure you don't catch a bad dose of "fear of missing out" and buy hot stocks just because you think they could keep running higher without having a firm grasp of what the underlying business does. But that doesn't mean that all stocks that have been roaring higher are worth avoiding.
Microsoft (MSFT 0.60%) is my personal favorite example of a mega-cap growth stock that has posted mind-numbing gains in recent years but is still arguably a good value. The company is accelerating its revenue growth while sporting decade-high operating margins and returning record capital to shareholders through buybacks and dividends. It has a clear path to more than tripling its market cap within the next 11 years.
So, while it's a bad idea to buy a hot stock for speculative reasons, it's also a mistake to completely discount a company or assume it's not a buy just because it is at an all-time high.
3. Investing in mediocre businesses
Another mistake to avoid in the second half of 2024 is putting capital to work in low-quality businesses.
There are many ways to evaluate a company, but at its core, it's really all about whether the business can continue growing earnings and meeting investor expectations. To do that, it has to have a strong balance sheet and a manageable debt position, a competitive edge in preferably multiple product or service categories, strong free cash flow to reinvest in the business, innovation, and a willingness to adapt and take risks, and it should meet dividend and buyback expectations if that's part of the value proposition.
Procter & Gamble (PG 1.04%) is an example of a high-quality business. It has an elite portfolio of brands across several consumer goods categories. It has raised its dividend every year for 68 consecutive years and regularly has leftover cash to buy back its stock. Management is careful not to overexpand the business and instead prefers to reinvest in existing brands. Procter & Gamble is a simple, boring, but effective dividend stock that can be relied on no matter what the economy is doing.
By comparison, a low-quality business may take on excessive debt and become overly leveraged just because it is doing well right now, only to see losses amplified during a downturn. Other companies may have years or even decades of past success but have poor management teams that are too complacent, leading to lost market share over time.
Another form of this mistake is using a stock's price as a yardstick for whether it's a good business. Just because a stock has beaten the major indexes in the short term doesn't mean it is a good business. There are plenty of examples of once-hot stocks that imploded or suffered irreversible losses. A stock's price and short-term performance are merely a reflection of consensus market sentiment in a moment. Over the long term, fundamentals tend to win out, bubbles burst, stories fade into history, and new characters capture the spotlight.
While no one knows what the future will bring, you can avoid a bad company tanking your portfolio by investing in your highest conviction ideas and maintaining diversification from a medley of individual holdings, ETFs, or both. As we mentioned earlier, it's very important to be hyperaware of allocation so your portfolio isn't too concentrated in a company that you're comfortable with.
Developing healthy habits
Every investor makes mistakes. And if you've been investing long enough, chances are you have some particularly painful decisions you'd rather not revisit.
We can't prevent all mistakes, but we can take steps to try to limit them.
Hopefully, these lessons can help you apply checks and balances to your portfolio to position yourself for success in the second half of this year and for many decades to come.
