With less than two months to the end of 2024, the S&P 500 is up nearly 26% through Nov. 7. 

If this holds up, it will be the fifth year in the past decade in which the index delivered an annual return of 20.0% or higher. Over the same period, the index has had only two down years: 18.11% in 2022 and 4.38% in 2018. 

It’s no wonder that investors are diving into stocks like drunken sailors downing beer at a pub open 24/7. Making money in the markets is addictive. FOMO appears to be setting in. 

The Globe and Mail, Canada’s national newspaper, recently discussed why you probably have too much money in the stock market, pointing out that the Canadian household stock market exposure is at near-record levels.

“I find the general public is pretty plugged into financial news right now,” Kurt Rosentreter, senior financial adviser at Manulife Wealth, told the Globe and Mail’s Tim Shufelt. “The longer it goes on, the more people you see looking to pile in and increase their stock exposure.”

So, how do you know if you have too much money in the stock markets? Here are three ways.

Key Points About This Article:

• When valuations near record highs, Mr. Market hints that you might have too much in the stock markets.  
• Significant gains make your portfolio underdiversified or reliant on one or two stocks.    
• Having sell rules avoids having too much money in the stock markets. 
• Sit back and let dividends do the heavy lifting for a simple, steady path to serious wealth creation over time. Grab a free copy of “2 Legendary High-Yield Dividend Stocks” now.

Valuations Are Too High

The average S&P 500 stock has a dividend yield of 1.25% as of Nov. 5. The last time it was this low was in August 2000, right in the middle of the dot.com bubble. The highest it’s been since 1957 was 6.66% in 1982. 

In October, Mathieu Racheter, Head of Equity Strategy Research for Swiss-based investment manager Julius Baer, asked if the S&P 500 was overvalued in an article on the firm’s website.

“While many indicators suggest that the market may be overvalued by historical standards, structural shifts in the economy and low interest rates provide some justification for these valuations,” Racheter wrote on Oct. 21. 

Racheter pointed out that today’s CAPE (Cyclically Adjusted Price-to-Earnings) ratio is upward of 30, considerably higher than the historical average between 16 and 17. Some will suggest this is evidence the markets are overheated, while others say the S&P 500’s valuation should be higher today, given all of the high-margin tech companies in it. 

Well-known Canadian economist David Rosenberg, who correctly called the 2008 recession, believes that the S&P 500 is 25% higher than where it should be based on current fundamentals. 

“Prices have outpaced earnings growth in the past year and if this were a classic earnings-driven rally, the S&P 500 would be sitting near 4,600, not at 5,751,” Business Insider Nederland reported Rosenberg’s October 9 comments. 

One month later, the index is closing in on 6,000. 

As they say, “the markets are priced for perfection.”

You’re Under Diversified

 

Let’s say you own 20 stocks you bought five years ago, investing an equal amount in all 20. Today, one of your stocks, Nvidia (NASDAQ:NVDA), accounts for 20% of your entire portfolio, with the remaining 19 averaging a 4.21% weighting.

While that might seem like a good thing, given that NVDA stock is up 207% year-to-date, you probably established equal weighting in the first place to maintain an informal cap on the amount you invested in any one company. 

Should something unforeseen happen to Nvidia’s business and its shares lose half their value overnight, the four-fold exposure to your current NVDA stock would significantly damage your long-term returns if you panic and sell your holdings.

Plenty of ETFs and their benchmark indexes have caps for this reason. You never want to sell a stock out of fear. By allowing your portfolio to be under diversified, you’re just begging for a correction to turn a good year in the markets into a bad one. 

Diversification matters regarding the number of stocks and asset classes you own. If you operate a 60/40 portfolio invested between stocks and bonds, frothy markets like we’re currently experiencing can throw your asset allocation model out of whack, affecting how your entire portfolio performs, effectively defeating the purpose of a 60/40 portfolio in the first place. 

You Don’t Have Any Rules for Selling

Investors have many rules for buying stocks but very few for selling. 

That’s not a problem when your benchmark indexes aren’t particularly overvalued. However, in times of irrational exuberance like we might be experiencing late in 2024, it’s essential to have a process for setting off sell orders that are not based on a hunch but on actual information and analysis. 

One sell rule that helps investors avoid overconfidence is the sell-half rule. It’s beneficial with fast-moving stocks like Nvidia. The rule is simple: when a hot stock doubles in value, you automatically sell half your holdings, returning your initial investment while letting the other half ride for more profits. 

While this rule generally only applies to riskier investments, which Nvidia sometimes can be, using it for all your stock holdings is not bad. This will effectively automate your investing and remove the emotional component.

Investors should remember that having sell rules ensures they never stay in a stock too long, exposing their portfolio to unnecessary and likely unwanted risk.

The higher your wall of worry, the more likely you’ve invested too much in the stock markets. 

 

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