“How To Invest In An Overpriced World”…

My apologies to The Wall Street Journal for stealing their headline from an article by Burton Malkiel on how to best position yourself in today’s uncertain times. Malkiel is important to listen to since he is the author of the all-time Investment classic, A Random Walk Down Wall Street.

With the market increase in 2018, the Standard & Poor 500 price to earnings ratio (PE) based on next year’s earnings is slightly above the long term average of 15. This is not Bubble territory, but it certainly means investors have to pay attention since prices are a long way from the lows of 2009.

So what should we be doing today? Malkiel argues you don’t need to do things that differently. You should stick to your long term investment strategy, keep some funds in things which will grow (stocks) and some in more stable assets (cash and bonds). And don’t forget to rebalance. With stocks up 20% the past year, equities now make up a bigger percentage of your portfolio than previously. If and when a correction comes, you don’t want to be overly exposed to risk.

Also make sure you are fully diversified. With respect to U.S. stocks, consider some real estate exposure. Real Estate Investment Trusts or mutual funds which invest in them get you this exposure. They will often zig when the broad market zags and vice versa. This is good for diversification. Foreign investments also help. U.S. stocks account for a smaller percentage of the total world stock market every year. You need global exposure. In IRA portfolios here, we allocate 50% of our stock exposure to the U.S. market, 30% to International markets including Europe, Australia and Japan and 20% to Emerging Markets. This reflects the global world we live in.

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Two other things that Jason Zweig pointed out in his Wall Street Journal column, The Intelligent Investor.  Don’t fall into the “beginner’s bubble” trap where you overestimate your chance of winning. Success in your portfolio breeds the idea of more success. But life is more like a metronome, swinging one way and then the other. Corrections happen. A second behavioral mistake is assuming that high rates of return in the past predict returns in the future. Zweig points out that sophisticated institutional investors today managing endowments and pensions on average assume that the stocks in their portfolio will return 8.7% over the long term. 

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Historically stocks have indeed returned this amount, if not more. But based on today’s conditions and the level of interest rates and the current above average market PE, many pundits feel a return of 5% to 7% is more realistic. We agree with this lower assumption, which is still profitable relative to expected inflation of 2 to 3%, but which is far from 8.7%.

In these unsettled times, our best advice is to stay focused on the long term and stick to your asset allocation. Stay as emotionally balanced as you can and as the volume of stock market chatter increases, learn to go sit quietly in your room!

And remember, volatility can lead not only to worse times but also better.  The dismal productivity numbers of the past decade might just reverse.  All is not lost that is in peril.