Whilst investors have enjoyed the rally of the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) over the last 18 months or so, it is also vital that they don't get caught up in the gains and neglect some of the key fundamentals of investing.
Since the beginning of June 2012, the benchmark index has climbed an astonishing 30.5%, led by some of the nation's largest corporations including the big four banks, Telstra (ASX: TLS), Wesfarmers (ASX: WES) and Woolworths (ASX: WOW). However, the gains haven't been restricted to the blue chips, with numerous growth stocks also following closely behind.
Although it is nice to watch the value of our stocks climb (particularly in such a short period of time), a problem also arises in that it is easy to get caught up in the rally and expect your stocks to continue climbing indefinitely whilst forgetting important elements of investing including diversification, a balanced portfolio or investing for the long term.
In November, the ASX 200 fell 1.9% — its first monthly fall since June. The beginning of December hasn't been too bright either, with the index falling 1.5% within just two trading days. Whether or not we are in for a market pullback is anybody's guess, but it is imperative that investors be prepared.
Firstly, investors should review the weighting of their portfolio. That is, look at the proportion of your portfolio that each company represents and determine whether or not you are comfortable with that level.
For instance, if your portfolio is too heavily made up of growth stocks that could be more vulnerable to a downturn in the market, perhaps you should consider building a stronger foundation. Telstra or other companies such as Twenty-First Century Fox (ASX: FOX), Coca-Cola Amatil (ASX: CCL) or Washington H Soul Pattinson (ASX: SOL) could be ideal at today's prices.
Second, ensure that your portfolio is made up of companies that cover various sectors of the economy. For instance, whilst the banks may have performed strongly, if your portfolio is heavily made up of shares in ANZ (ASX: ANZ) and Commonwealth Bank (ASX: CBA), you may need to consider re-allocating some of those funds.
Third, it is vital that you maintain a cash pool in case of a market downturn. Whilst it is certainly appealing to pump all of your spare funds into stocks due to their higher average returns, if the market falls significantly then so can your net worth, making it important to hold at least some cash.
What's more, if stocks do fall in value, then some of the cash can be used to purchase discounted stocks for a chance at even greater long-term returns.
