With the Dow and S&P 500 closing at new record highs, investors are left to ask themselves: Did I miss the rally, and is it too late to jump in?
These are legitimate questions, and I’ll answer both in turn … but they are really the wrong questions you should be asking if you are planning for retirement or are retired already. Instead, the two most fundamental questions you need to ask first are:
- How much income do I require to fund the lifestyle I want in retirement?
- What is the best way to generate that income?
Most of my friends and colleagues consider me to be a “stock market guy” because I spend the vast majority of my working hours researching and writing about the equities markets. But I don’t really consider myself a “stock market guy,” per se. I’m simply an investor looking for a good return on my capital and I consider the stock market one of many good hunting grounds.
Stocks are also more liquid and easier to invest in for passive portfolio investors than a lot of the alternatives such as rental properties, small businesses or assorted alternative investments.
So with that said, how does the stock market look right now? Before I answer, let’s circle back to the questions above. I can’t tell you how much income you will need in retirement, but I can tell you this: As far as liquid, easily tradable investments go, you are going to have better luck building a growing stream of income in the stock market than anywhere else these days.
Cash pays nothing, and I consider bonds downright risky at current prices. Mutual funds or ETFs that follow the broader market, such as the SPDR S&P 500 ETF (NYSE:SPY) and the SPDR Dow Jones Industrial Average ETF (NYSE:DIA), yield around 2%.
But you can easily build a conservative portfolio of dividend-paying stocks, REIT and MLPs that pay 5% or more and whose payout are likely to rise over time.
Of course, as we saw in 2008, a 5% dividend doesn’t amount to much when the market value of your portfolio falls by half. So anyone who tells you that you should always be fully invested in the stock market is either delusional or simply has a very poor grasp of history. There are times when you should be out of stocks — such as when they are grossly overpriced.
But rather than get out of stocks altogether — and miss any potential for further gains — it generally makes sense to take a more gradual approach. After a good run in the stock market, you likely should rebalance your portfolio closer to your “ideal” allocation.
Very few investors are good at precise market timing. I’m certainly not. But the good news is that you don’t have to be. By simply taking an active approach to rebalancing, you get most of the benefit of being a good market timer without the wild swings in performance and the ugly tax consequences that go with it.
All of this brings me back to the first lines of this article. Is it too late to invest in this market given that the major stock averages are at all-time highs?
No, it’s not. Stocks remain attractively priced, particularly given their competition among traded assets. But if you are currently out of the market, I also know it can be psychologically difficult to buy after watching a large run-up. We instinctively fear buying at the top.
When my mind tells me to invest but emotions tell me not to, I split the difference. Rather than go all in, I start small and average my way in over the course of a few weeks or a few months. Is this a scientific approach? No, but it helps me to manage my emotions, which is the single hardest aspect of the investing process.
If you are already fully invested and feeling nervous, the same rules apply. Don’t pull all of your money out at once. Rebalance your portfolio to take a little money off the table, or average out in stages.
Or better yet, as you grow as an investor, build a rebalancing strategy that fits your disposition. Investing does not have to be a “once size fits all” endeavor.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar but also which stocks will deliver the highest returns. The series starts November 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.