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Introduction:

As the stock market continues to move ahead, it seems that many investors are becoming concerned and worried about valuations. I've been seeing more and more articles being written that talk about "the coming meltdown" and what you need to be doing with your investments.

In a recent article at Marketwatch, Paul Farrell warns that the market is due for a correction.

Farrell sees only four options for investors moving forward. Here's what he says those options are:

  1. Cash out. But only if you are super savvy.
  2. Cash in. Day trading, double down, shorts, calls, action!
  3. Sit tight, do nothing, ride out the storm.
  4. Start building your own "Lazy Portfolio" today.

To Farrell, the correction is inevitable. It's happened before and it will happen again. It's just a matter of "when," and not a matter of "if." Which option would you choose for your plan of action, moving forward?

What I Know:

As a Dividend Growth investor, I purchase stocks that I believe are value priced; that have a history of paying dividends and increasing those dividends annually; have the earnings power to continue raising those dividends; and preferably they have been growing those dividends at a rate that is greater than inflation.

Investing since 1984, many of my holdings have appreciated greatly. Some of my holdings have had run ups in price, split, and then run up again, only to split over and over. Holdings that come to mind are Coca-Cola (KO); McDonald's (MCD); Kimberly-Clark (KMB), and Colgate-Palmolive (CL) among those companies.

As a result of those stock splits and reinvested dividends, my positions in these companies have grown very well and as a result, my cost basis for these and many other long-term holdings are significantly below current market prices. A decline in share values for these long-term holdings would be disappointing, but it would not result in a crisis situation for my retirement years as dividends continue to roll in.

Now, companies that I have purchased recently and do not have a cost basis that would protect me with a 20-40% decline in market prices are another story. My most recent purchases (over the last 5 years) are companies like Emerson Electric (EMR), Illinois Tool Works (ITW), Harris Corp. (HRS), Aflac (AFL), Safeway (SWY), Staples (SPLS), CA Technology (CA), Western Union (WU), CSX Corp. (CSX), and Norfolk Southern (NSC). While these companies have appreciated since their purchase dates, they have not, with the exception of SWY, given me protection from a 20-40% market correction.

However, as a DG investor, the reason I purchased those companies was not contingent on capital gains, but the income stream that is produced by dividends. In any case, one of my investment habits is to rebalance my portfolio twice a year and in doing so, I find myself being able to take "money off the table" and give myself cash to reinvest in companies I already own that may be value priced - or finding new opportunities as they present themselves.

What You Need To Know:

Like Farrell, I believe the market is due for a correction. However, with that possibility in mind, it doesn't mean that investors should be overly concerned and should, instead, be looking at what their investment objective is and whether or not that investment objective is still applicable to today's market conditions.

Every investor should have a clearly defined investment objective. For those in the accumulation phase, that objective might very well be capital growth. For an investor who is approaching retirement, perhaps the investment objective is preservation of capital. And for those who are in retirement perhaps that objective is an increasing dividend stream, one that outpaces inflation with dividend growth rates above the prevailing rate of inflation.

Unless you have clearly defined that objective, it becomes difficult at best to develop a strategy that you can use to achieve that objective.

My own plan is simple. I believe that maintaining a balanced portfolio of dividend growth stocks with annually increasing dividends is the way to achieve my objectives of increasing income. I also believe that there is no reason to look for hitting home runs when my strategy involves achieving a better "on-base" percentage.

So taking a look at my overall portfolio and the value of each position shows me that I am overweight in some of my holdings and underweight in others. By rebalancing my portfolio, I am able to keep each holding within that portfolio from becoming too large of a position.

Now, it might be argued that "you're selling your winners," To that I would disagree. Many of the holdings are longer-term holdings and have had multiple years of growth. Others are relatively new positions and have had less time to grow (looking at CAGR might be very valuable with this exercise). By rebalancing, I am able to add to some positions with money taken from others and can find myself in a position of increasing my dividend income; having that increased income carry on into the future; and not have any one particular stock that can experience a "blow up" and hurt my overall portfolio.

Whatever you decide to do - whether it is one of the four options that Farrell suggests, some combination, or an option that you have devised for yourself is really up to you and your long-term goal.

Summary and Conclusion:

The market will go up and the market will go down. Individual stocks will likewise do the same. A market correction, in my opinion, is a real possibility, but I don't know when that will happen or how big it might be. All I can control is my own portfolio and invest with an objective in mind and a strategy behind that objective to execute the goal of my investment philosophy.

Every investor is different and every investor is the same. We allow ourselves to be caught up in the emotions of investing, the excitement of having a "winning" position, and to a certain extent we allow greed to enter our decision making process.

I can't tell you what to do, but for me, I think the option that I have explained makes the most sense for me. I will remain invested, but structure my portfolio to minimize risk.

Source: What Do You Need To Do Before The Next Market Meltdown?