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5 steps to help investors get back into the market

  • Investors waiting for a market pullback could miss out on years of gains.
  • Assess market conditions and your risk tolerance and financial flexibility before acting.
  • Weight portfolio shares at variance with major market indexes.

Individual investors quite often are holding back in a bull market, thinking that merely waiting for a pullback to invest is strategy enough. And just as often, those who come into large sums through insurance proceeds, a divorce settlement, the sale of a business or inheritance suddenly jump into the market, making big stock purchases without much discretion beyond assuring diversification.

Those waiting for a pullback could end up suffering the market's version of waiting for Godot, possibly missing out on years of gains. And jumping in indiscriminately just because you've recently come into a lot of cash could mean a long wait for returns.

Investors who are looking to reenter the market should follow a series of careful steps.
Ezra Bailey | Getty Images
Investors who are looking to reenter the market should follow a series of careful steps.

Investors who have been withholding their cash from the market or those who have recently had a liquidity event and are seeking to make substantial investments for the first time may have some things in common regarding investing readiness — or lack thereof. Not only might they lack a sound investment methodology, they also might not have any personal context for determining one.

These investors would be more likely to succeed if they followed these five steps.

1. Assess your tolerance for investment risk. This may be much tougher than you think. Many believe they have a high investment risk tolerance, until they experience significant losses and the despondency that ensues. Many advisors have questionnaires for clients aimed at determining their tolerance. Sometimes, to answer these questions honestly, clients need to undertake considerable reflection.

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2. Determine your financial capacity for risk. How much risk you can afford to take with your investment portfolio during retirement, or when approaching it, depends on your cash flow from available income streams — such as pensions, Social Security benefits or annuities — and doing a thorough cash-flow analysis is paramount. If you're depending on your portfolio to throw off a certain amount of cash and you take too much risk by choosing investments that are too volatile, you could come up short regarding your living expenses and be forced to accelerate withdrawals, increasing the chances that you'll run out of money or shortchange your estate.

3. Identify market sectors that are currently viable relative to where the economy is in the business cycle. For example, contracting economies mean investing in safe, defensive sectors, such as consumer staples (people brush their teeth in all cycles) and utilities. In a developing economic expansion, people spend more, so consumer discretionary companies such as entertainment enterprises tend to do well. In the later stages of an expansion — where we are now — basic materials are a good play, as are financials in this rising interest-rate environment, which creates lucrative spreads for banks and financial services companies.

4. Identify generally promising-looking companies within these sectors, and evaluate them as portfolio candidates based on earnings momentum and intrinsic value. Many investors make the mistake of looking only at current or recent earnings, which are nothing more than meaningless snapshots of where a company is or was. Instead, use earnings momentum to see where earnings are headed — up or down.

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Earnings momentum figures for various companies can be found online, but getting a sense of this is hardly rocket science. Just look at the pattern of earnings reports over the last eight or so quarters, read analysts' projections for future earnings, and look for a pattern. If a company posted its best earnings of the last five years two years ago and has been lackluster since, perhaps it's under increasing competitive pressure, so have a look at qualitative factors showing what's going on. Positive earnings momentum alone doesn't make a stock desirable.

You must also make sure you don't pay too much for it, and that's where intrinsic value comes in. Intrinsic value often deviates from market value in the short term because of market perception and behavioral investing factors. Ideally, of course, you want stocks whose intrinsic value is higher than their market value. Analysts determine intrinsic value using either absolute valuation or relative valuation models, and some use both. Either way, it's a tricky business, relying on both art and science, and can only be expected to yield an approximation at best.

"Depending on your level of confidence in a certain sector, over- or underweight your numbers of shares of stocks in that sector in your portfolio, relative to the weightings of the major market indexes."

The best course for individual investors is to use online resources to get these numbers. In the process, keep in mind that the least accurate valuations are those done with short-term inputs. As intrinsic value and market value tend to align in the long run, the trick is to spot meaningful differences by analyzing the reasons the market may be currently undervaluing a stock, and act before these windows of market inefficiency close.

5. Weight shares in your portfolio according to a strategy that varies from that of major market indexes. In other words, depending on your level of confidence in a certain sector, over- or underweight your numbers of shares of stocks in that sector in your portfolio, relative to the weightings of the major market indexes. That way, a plummeting S&P 500 may not mean as steep a decline for your ownership in sectors represented in this index.

Getting into the market initially or making huge purchases can be truly daunting. Following these steps can make the process less so.

— By David Robinson, founder and CEO of RTS Private Wealth Management

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