Why some fear can be healthy for investors

• We are in the midst of an eight-and-a-half-year-old bull market, the second longest in history, and investors are showing no fear of it ending.
• But a healthy fear that keeps investors focused and evaluating decisions is always good.

Sam Edwards/Caiaimage | Getty Images

A dose of healthy fear is good for investors, even during bull markets.

The year 2017 was a good year to be an investor. The Dow Jones Industrial Average just passed through the 24,000 level for the first time ever. The S&P 500, a broader measure of the market, finished higher in November, making it 13 months in a row of gains, also a record. Both indices are more than 20 percent higher than where they started the year.

It seems that every day, the headline on CNBC reads "Markets Hit New Record High." In fact, we are in a bull market that is now eight-and-a-half years old, the second longest in history.

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That's good, right? As an investment manager, we think it's great for our clients to see gains in their portfolio each month. But as an investment manager with more than a few years of experience, we also think it's a little bit scary. Markets aren't supposed to go straight up all the time.

The economy is doing fairly well and is starting to show some signs of stronger growth. Unemployment is low, which means more people are working and spending money, which helps to spur the economy. Corporate earnings have been pretty good, and the holiday retail season seems to have started off well.

Fear is good for investors

So what's the problem? Last week a headline in The New York Times read "Markets Pass Another Milestone, as Investors Remain Fearless." That's the problem. Investors seem to be fearless. A healthy dose of fear is good for investors. I'm not talking about an irrational fear that paralyzes. I'm referring to a healthy fear that keeps investors focused. It's the type of fear that makes you evaluate your decisions. A lack of fear leads to "irrational exuberance," when investors buy indiscriminately, not paying attention to the fundamentals of their investment decisions.

Actually, there is some fear in a market like this. It's the fear of missing out. Others might call it greed. One of Warren Buffett's famous quotes about investing is, "Be fearful when others are greedy, and be greedy when others are fearful."

The importance of diversification

So while it is certainly okay to enjoy the gains that we've been experiencing, we should also be preparing for the time when real fear returns to the markets. We do that by making sure that our portfolio is properly diversified. We should also rebalance regularly so that we are able to capture the gains we have enjoyed and to maintain the proper risk level in our portfolio.

In 1932, when President Franklin D. Roosevelt delivered his first inaugural address, our country was struggling. We had not recovered from the market crash of 1929, assets values had fallen dramatically, taxes had risen, and the citizenry's ability to pay those taxes had fallen. The country was facing tough economic times. In his inaugural speech, FDR tried to reassure the country by suggesting that "the only thing we have to fear is fear itself."

In today's markets, the main thing that we have to fear is the lack of fear itself.

(Editor's Note: This article originally appeared at Investopedia.com)

— By Bob Rall, principal of Rall Capital Management