The stock market is hitting all-time highs. Why you should still invest.
If you’re listening to the news, you hear that the stock market (S&P 500 and Dow Jones Industrial Average) have been hitting all-time highs. At the same time, many investors, who are scared off due to memories of the great recession and the dot-com bubble, have been pulling money from the markets and putting money into bonds. I’m going to lay out a few strategies that are better than pulling money out of the market.
Continue investing as you were
If you’re a long-term investor, you know that time in the market is more important than timing the market. Millions of people try to time the market, and they lose when they try. Another idea that has been fully supported by the investment management community, is diversification. The biggest reason financial advisors stress diversification and moving money out of the market into bonds, is that it limits downside risk in any given year. This aligns with their incentive of not having you move your money away from them. When the market turns negative, and there will be periods where its negative, they are hoping to be able to keep you from moving your money by stating that your account didn’t go down as much as the market did. However, what you’re missing is, that you probably missed a lot of upside while you had money sitting in cash or bonds. You should keep investing, as it shouldn’t matter what happens over the next couple of years, you should only care about having as much money as possible in the best performing asset classes. Inevitably, that is the stock market over the long-term.
Invest in under-performing areas of the stock market
My first point is around keeping money invested in the market, and continuing to add, regardless of recent market performance. Another option is looking for areas of the stock market that have under-performed. As of July 2019, the European stock market hasn’t come close to matching the returns of the US market. A major factor is the lack of technology companies in their large company indexes. Instead of being afraid of investing and putting money into cash, you can look for an out of favor area of the market. While the S&P has returned around 15% over the last decade coming out of the great recession, the top investment cycles don’t last forever, and there will eventually be a change in the top area of the market.
Small Company stocks have historically been the best performing area of the stock market
Small cap stocks have been a bit more volatile over the last couple of years. They have slightly under-performed the S&P 500 over the last decade. Generally speaking, the uneducated investor will flow more money to areas of the market that have performed the best. I recommend always having a large portion of your investment portfolio in small caps. Any volatility is just an invitation to add to your small cap holdings.
Don’t forget about value investing
Value investing is another area that has really lagged growth investing. I see articles stating things such as “value investing is over”, thinking that somehow this time its different. But I believe this is another cycle. There will be a time where value investing will once again become a market leader. Many value companies have very strong cashflow, lowering their share counts through buy-backs, and pay good dividends. Dividends are a great creator of wealth over time, especially when those dividends are reinvesting. There are a couple of other factors that will eventually lead value investing to make a comeback: continuing low interest rates and the aging population.
These two topics are related. Many traditional asset allocation models and income portfolios are counting on bonds having interest rates in the 5-6% range. In today’s environment, you need to be looking at junk bonds or low grade bonds to find those types of yields. Most high-quality bonds are paying 2-3%. Instead of looking at bonds, that typically don’t appreciate over time, investors will more and more move money into dividend paying stocks, where they can achieve 2-4% dividends, and still achieve capital appreciation. Currently, ExxonMobil (XOM) and AT&T (T) are examples of large value plays, paying dividends in the 5-6% range. They have not been exciting stocks to invest in. However, if there is a period where the high-growth technology sector pulls back due to slowing growth, these large value names should attract a lot of attention and get their dividend yields down in the 3-4% range. I recommend adding these types of names to your portfolio, and either reinvesting the dividends back into these companies to get a compounding dividend, or taking the dividends and putting them into a small cap index.