“If the world was perfect, it wouldn’t be.” – Yogi Berra
Common sense reader mailbag: What am I supposed to invest in these days? Stocks are probably overvalued or at the very least due for a severe pullback with such huge gains over the last 5 years. And bond interest rates are extremely low so they don’t look so great either. Where should I put my money?
As we have seen lately, markets can be very unaccommodating from time to time. There are times when absolutely nothing works. In the past few months we have seen stocks, bonds and commodities all sell off in unison.
The reason for this? Who knows. You will hear explanations about the Fed and monetary policy and bond bubbles, but maybe it’s just a case of investors sitting on pretty good gains half way through the year and taking some profits while buyers are only willing to pay a lower price for their investments. Don’t try to explain short-term market moves because there is no rhyme or reason.
Stocks have been performing unbelievably well the past five years in the absence of many good alternatives.
In fact, many investors have the impression that the last few years of stocks gains happened because of the TINA phenomenon (There Is No Alternative). Stocks have basically been the best house in a bad neighborhood (which is actually kind of scary since realtors generally tell you to avoid that option when buying a house).
Whatever the reasons for the stock market’s rise, the current levels and recent gains have people worried about another big pullback in the markets. I don’t know if stocks are overvalued or undervalued.
Some measures show stocks being fairly valued to undervalued (P/E ratio, relative to interest rates) while some say stocks are overvalued (CAPE, peak profit margins). Stocks are just at the level that investors are willing to pay for them at the moment. That’s all you need to know.
We know that stocks have averaged a 10% correction every year and have gone down by 20% every three years on average. Because of this stocks also offer you the best shot at earning high returns on your capital.
And we know that over the long-term, bond performance typically comes pretty close to the average prevailing interest rates over your investment period.
In the past investors could simply move some of their investments into bonds and earn a nice rate of interest in a safer asset class if they got nervous about stocks.
Only now bond investors have to deal with a low interest rate environment that doesn’t offer a whole lot of downside protection when interest rates rise, as we have seen of late. Anyone invested in bonds in the months of May and June understands this dynamic as rates rose fairly quickly and bonds sold off (remember, bond rates and prices are inversely related).
SO WHAT’S AN INVESTOR TO DO?
I wish I could pull out my crystal ball and give you the perfect portfolio solution to get you through these interesting times. Buy tech stocks in July, but switch to corporate bonds by September and then sit in cash from October until year end.
If it were only that easy.
The problem is that no one’s going to tell you when the market shift is going to occur because no one knows. Investment forecasts can be rooted in very detailed, intelligent research and analysis, but at the end of the day it’s all one big guess over the short-term.
It would be great if we could all have the foresight to be able to shift seamlessly from one outperforming market or asset class to another. Unfortunately, no one can predict the future so it makes sense to have a balanced and diversified portfolio of investments.
Diversification matters when you invest, but especially in this type of environment. Spread your bets and rebalance more frequently. You should probably plan on diversifying within each asset class and on a global basis as well. These markets tend to ebb and flow with some outperforming others during certain time frames.
But if you’re nervous about stock and bond returns going forward, what alternatives do you really have to create a low-cost, simple investment portfolio? Bury gold in your backyard? Wait things out in cash and lose out to inflation over time?
John Bogle had this to say on the TINA markets recently:
“This is not a particularly cheap market to invest in. But, the problem is that we must invest. We can’t stand back. If you don’t save anything, I guarantee you will end up with absolutely nothing. There’s no such thing as a bad market. If the market goes way down, that’s good for buyers and bad for sellers. We’ve let the emotions—the excitement of the short term—take over our thinking about [our goals]—basically a long-term plan to fund retirement. Maybe not today, but over the long run stocks are going to be the best way to get there.”
There have certainly been better times to be an investor than right now. Stocks have had much more attractive valuations and bonds have had much higher rates of interest. So, sure, there could be some below average returns for a few days, weeks or even years. Who knows?
But as Morgan Housel pointed recently, the advantage that you have as an investor is that you don’t need to worry about the short-term if you have a time horizon of 10, 20 or 30+ years.
You can have a long-term mindset to try and avoid making short-term guesses about how things will play out. Take a look at this chart that Housel provided on the percentage of investment periods that have achieved a positive return for stocks since 1871:
Obviously, you increase your odds of success by having a long-term mindset. Sell offs never feel good, but a 7-10% correction (or even a 20-30% loss) doesn’t even register over a 30-40 year time horizon. If you are still in the wealth accumulation phase of your life you should actually welcome periodic market downturns. It increases your future returns when you buy lower.
And if you need to use your investments for near-term spending purposes don’t take unnecessary risks to try to make a few extra pennies here and there on a higher rate of interest. Play it safe.
INVEST WHEN YOU HAVE MONEY
I will leave you with a story from Mark Mobius, the seasoned portfolio manager from Templeton Investments, about a simple, yet effective way to think about your investments:
One seemingly simple question asked by a young lady years ago at a conference in Canada which I attended with the founder of Templeton Investments, the late Sir John Templeton, was particularly timeless. She asked: “I’ve just inherited some money from my grandfather. When is the best time for me to invest it?” Sir John was at the podium, and after a brief pause, gave an equally simple answer: “Young lady, the best time to invest is when you have money.”
Investing is simple, but not easy. You have to be patient and remember that it’s not always going to be a great time to be an investor in certain markets. A long-term outlook with a disciplined process is one way to help you through the tough investing periods.
Another way to reduce your risk is by saving more. Increasing the amount you save is a guaranteed return on your portfolio. And remember the level of the Dow or the 10 Year Treasury rate on a daily basis has absolutely no bearing on your long-term goals as a person and an investor.
Here are my weekly links:
- The Daily Show: Canadian vs. US Banks (Daily Show)
- Four Lessons Every Investor Must Learn (CBS Moneywatch)
- Why Behavior Is Half The Battle (Reformed Broker)
- 7 Mutual Fund Ads You’ll Never See (MarketWatch)
- A Commotion to Wake The Dead (The Big Picture)
- Portfolio Managers Face Their Kobayashi Maru (Reformed Broker)
- How Warren Buffett Would Handle Today’s Market (CBS Moneywatch)
- The Overconfident Investor Moves Markets (US News)
- Spreadsheet Fiction: The Delusion at the Heart of Tech Stock Analysis (Atlantic)
- 9 Qualities of Truly Confident People (LinkedIn)
- Gold Was a Horrible Investment From 1500 to 1965 (Atlantic)
- Polling the Public About Investing (The Big Picture)
- The Most Lucrative Movies of All-Time (Bloomberg)
- Good Investors Avoid Being Anchored (Dividend Growth Stock Investing)
- The Wrong Kind of Diversification (Rick Ferri)