With the stock market near all-time highs and interest rates near all time lows many investors are probably wondering where to put their money. There is no obvious answer, but a careful analysis will lead to a reasonable approach to follow.
When the stock market sets an all time high that may or may not mean the market is overvalued. For example, during the tech bubble in late 1999, the stock market was over priced on excessive optimism, but there were numerous times in the 1980s and 1990s when stocks hit new highs and continued to advance.
The same phenomenon occurs in real estate. When housing prices hit an all -time high in 2006-2007, the real estate market was overpriced. However, in prior decades, as with stocks there were numerous instances when housing prices hit new highs, only to continue to much greater levels.
In a growing economy and one where corporate profits are increasing stocks should hit new highs. One may argue with how fast the economy is growing, and clearly the recent growth rate is well below what many have previously experienced. However, only the most pessimistic person would consider it likely that corporate profits would turn negative for a sustained period of time.
Looking at the current environment, there is a stock market during the last few years that appeared somewhat undervalued. Presently stock prices appear fairly priced, assuming the nation continues on the path of modest economic growth. While there are some cautionary signs, such as increased selling by corporate insiders, a long -term investor should still maintain a reasonable allocation to stocks.
For those investing in bonds there are significant differences versus stocks. Unlike stocks, which can continue to rise over time, interest rates have a floor, which is zero. Even if interest rates stay at current levels, the returns for a bond investor are quite low. 10 year U.S. yield 2%, so with inflation at approximately that level, someone’s real return is essentially zero.
If an investor investing in a 401(k) or an individual retirement account (IRA) has a portfolio primarily in bondsinvestment will unlikely provide adequate appreciation for retirement. Even corporate bonds have yields only about 1% greater than Treasuries.
For an investor near retirement or already retired having some investments in bonds is still appropriate. However, I would keep the maturities relatively short, since longer term bonds could suffer a significant drop in principal value should interest rates rise.
The previous analysis was pertaining to U.S. markets. However, investors should also consider international markets. Many foreign stock markets appear more reasonably priced than the U.S. stock market. Even in Europe, with its many problems, most companies based there have significant sales throughout the world.
Emerging markets, which offer the best growth opportunities, have lagged the U.S. market in recent years. While emerging markets are somewhat riskier, having some money invested there is appropriate for a longer term investor.
For those investing in fixed income, interest rates in the rest of the world are also relatively low. Therefore, there would not be a major advantage for bond investing overseas, especially if the management fees are significantly higher. If your company 401(k) plan has the option for international bond investing, a small portion could be appropriate for diversification, if the fees are not excessive.
At present financial markets are not offering great bargains. However, for a long term investor it is still reasonable to have a normal investment in stocks, with some allocation to international markets. Fixed income investing is still appropriate for more conservative investors, though maturities should be kept relatively short.
