The year 2016 has been, for lack of better description, a strange one. It started with one of the worst Januarys in history and an oil price bust … continued with a surge of populist election surprises in Europe and the United States, and wrapped up with the Trump Rally — what might be remembered as the most unlikely rally in history based on pre-election sentiment.
So after a year like this, what will 2017 bring?
Frankly, your guess is as good as mine. I’m generally pretty optimistic, and I think it’s likely that the market surprises us to the upside next year. But I’m also a realist, and I also know that an aggressive Fed, surging bond yields and an expensive stock market all pose some pretty significant headwinds.
There are a lot of big question marks out there. But even with far greater uncertainty than usual, we still have to invest our portfolios in something.
So today, I’m going to cover 10 ways to make money in the market in 2017.
Some will be broad, while some will be specific stock and fund picks. Some will be fairly standard … perhaps even obvious. But others will be a lot different than the advice you’re reading elsewhere. Some might sound downright ridiculous, but hear me out. Unusual times call for unusual investing solutions.
Ways to Make Money in the Market in 2017: #1: Buy REITs
I really believe real estate investment trusts (REITs) are the single most attractive American asset class right now. REITs have gotten utterly obliterated by the recent surge in bond yields. As a sector, they are down about 14% from their summer highs, and many of the more “bond-like” conservative REITs are down by closer to 30%.
REITs are sensitive to bond yields for two reasons. First, they borrow a lot of money to buy their properties, so higher market interest rates cut directly into profits. Secondly, as income-focused investments, they are priced relative to bonds. So as bond yields rise (and bond prices fall), REIT yields rise (and prices fall).
But remember: REITs, unlike bonds, actually enjoy a rising payout over time. REITs tend to raise their dividend by at least a couple percent per year, more than keeping pace with inflation. And should the inflation that everyone seems to fear from a Trump presidency come to fruition, real estate should perform at least moderately well, as real estate is a natural inflation hedge.
That makes the Vanguard REIT ETF (NYSEARCA:VNQ) — which holds REITs such as Simon Property Group Inc (NYSE:SPG) and Public Storage (NYSE:PSA) — a natural play here.
This is the third time in three years that REITs have sold off aggressively on yield fears. The previous two times, REITs went on to soar to new all-time highs. Can we expect things to play out the same way the third? We shall see.
Ways to Make Money in the Market in 2017: #2: Buy Energy
The past two years have been rough for investors in energy stocks. If low oil and gas prices weren’t bad enough, there has also been constant political opposition to domestic infrastructure projects, such as the Keystone Pipeline and the Dakota Access Pipeline, both of which became cause célèbres for environmental activists.
Well, it remains to be seen what direction oil and gas prices go from here. The recent OPEC meeting seemed to show that the major crude exporters are serious about keeping prices stable. But virtually every member of the cartel is also known to cheat on their quotas, so we’ll see how this agreement sticks.
But regardless of what direction oil and gas prices go, I think it is all but certain that energy infrastructure does well. President-Elect Trump has already said that he intends to give the green light to the two contentious pipelines, and I expect that this is only the beginning. Meanwhile, midstream pipeline stocks are cheap after the thrashing they took this time last year.
So adding MLPs such as Kinder Morgan Inc (NYSE:KMI) to your portfolio makes all the sense in the world. Or you could add Energy Transfer Equity LP (NYSE:ETE), which is up 30% and in second place as the Best Stocks for 2016 contest nears a close.
Ways to Make Money in the Market in 2017: #3: Buy … Bonds?
OK, before you close this article in disgust, hear me out. I’m actually not going to recommend that you back up the truck and load up on bonds. Even after the massive surge in yields, bonds still don’t yield enough to be worth a major speculative allocation right now.
But let’s say that you’re in or near retirement and that you’re investing along the lines of a traditional 60/40 portfolio. The bonds aren’t going to be a major source of return at current yields, but they could definitely still be valuable as volatility reducers.
And this would seem like a sensible time to rebalance. Stocks have been flying ever since the election, but bonds are down sharply.
I expect stocks to cool down, at least for a few months, and I expect bonds to recoup a fair bit of their losses. We may not see bond yields back at July levels again, but I do expect them to be lower than they are today. The market is spooked that republican control of Congress and the presidency will lead to large deficits and resurgent inflation. But if large deficits were all that it took to stoke inflation, then Japan would have the highest inflation in the world right now. (Fun fact: It doesn’t. Japan’s CPI has barely budged in well more than 20 years.)
So, if you’re due for a portfolio rebalance, this would be a sensible time to do it, when stocks risen a little too far too fast, and bonds have fallen a little too far too fast.
One suggestion is the iShares 7-10 Year Treasury Bond ETF (NYSEARCA:IEF), which holds intermediate-term bonds.
Ways to Make Money in the Market in 2017: #4: Avoid Consumer Staples
While the broad market is expensive right now, not all sectors are equally overpriced. Some, like automakers, are actually pretty cheap.
But consumer staples stocks are just about prohibitively expensive. Investors have been wary of this bull market for year and have responded by staying invested … but doing so by overweighting the sectors that are traditionally considered the most conservative, such as consumer staples.
The result has been an overpricing of these “safe” sectors to the point that they are no longer safe. Even the most stable and predictable business can be a lousy buy at a price that is too high. Procter & Gamble Co (NYSE:PG) and Colgate-Palmolive Company (NYSE:CL) sport price-to-earnings ratios north of 20. Not worth it.
My advice is to stick with cheap consumer cyclicals via the Consumer Discretionary SPDR (ETF) (NYSEARCA:XLY). As I mentioned, automakers are particularly cheap, and the market seems to be pricing in steep declines in sales. So if anything other than the worst-case scenario happens, cheap consumer discretionary stocks should do just fine.
So the consumer trade for 2017 is dump staples and go long cyclicals.
Ways to Make Money in the Market in 2017: #5: Focus on Dividends
As I said before, I’m generally the optimistic sort. Over time, it has been unwise to bet against the market.
But I’m also a realist. I know that there are long stretches of time when stocks go essentially nowhere (think 1968-82). And I fear that, at today’s valuations, we might be in one of those periods today. The cyclically adjusted price/earnings ratio (CAPE) suggests that stocks are priced to lose about 1% per year over the next eight years.
I think that the market will do a little better than that … but not much. But so long as the stocks I own continue to throw off a high and rising stream of current income, I don’t necessarily mind. I’m never going to be able to time every bend and twist of the market correctly. But with a regular stream of dividends coming in, I’m able to realize a consistent, tangible return even if the market goes sideways from now until the end of time. And by reinvesting my dividends, I’m effectively dollar-cost averaging.
You should always be careful not to chase yield when looking for dividend stocks. If a yield looks too high to be true, it’s often a sign that it’s about to get cut.
But a portfolio yield of 3%-5% with dividend growth in the mid- to high single digits is both very achievable and very practical.
Ways to Make Money in the Market in 2017: #6: Don’t Drink the Buy-and-Hold Kool-Aid
I’m going against received market wisdom when I say this, but buy -and-hold indexing is not always the best strategy.
I should be clear: Index funds are very often the best strategy for long-term growth, as they are tax-efficient, have low fees and generally outperform their active counterparts. If we were in the early stages of a multiyear bull market, I’d recommend dumping a large chunk of your investment portfolio in index funds and simply buying and holding indefinitely.
But as I wrote in the last section, I’m not so sure we’re in that kind of market. This bull market is now nearly 8 years old, and prices are extremely elevated … at a time when the Fed will likely start raising rates. That’s not a recipe for long-term buy-and-hold success.
Consider investing at least part of your portfolio in an active strategy or in alternatives. Or, to the extent you buy and hold, do so with stocks paying a high and rising dividend.
Ways to Make Money in the Market in 2017: #7: Max Out Your 401k
This next recommendation might sound a little pedestrian, but here me out.
For tax year 2017, you can contribute $18,000 to a company 401k plan, with an additional $6,000 if you’re 50 or older. And that salary deferral. It doesn’t include any company matching or profit sharing.
These are standard figures. But what I’m about to recommend next might raise an eyebrow or two. If it’s not realistic for you to contribute the full $18,000 to $24,000 at your current salary level — but you have existing cash savings from prior jobs or from an inheritance — consider dipping into those taxable savings for your living expenses in order to max out your 401k plan. Doing so effectively transforms taxable savings into tax-free savings and gives you a current-year tax deduction to boot.
Now obviously don’t do anything stupid that will put your family at financial risk. You know your cash needs better than I do, and you should always keep several months’ worth of expenses in cold, hard cash for emergencies. But if you have taxable savings above and beyond those levels, you might as well get a tax break.
If you’re in the 33% tax bracket, you’re getting an instant 33% “return.” You’re not likely to beat that in the market.
Ways to Make Money in the Market in 2017: #8: Invest in a Roth IRA
Along the same lines, I’d recommend you invest in a Roth IRA if you qualify.
I’m often asked which is better, a Roth IRA or a traditional IRA. My answer? “Yes.”
It really depends on your tax situation and where your other funds are being invested. If you’re in a relatively high bracket, it makes sense to get the immediate tax break via a traditional 401k or IRA. But if you’re young and in a relatively low bracket, it makes sense to go with the Roth option, as you’ll benefit from having tax-free withdrawals later in life … or no withdrawals at all if you opt not to, as Roth IRAs are not subject to required minimum distributions.
You also have to consider how your other funds are invested. If you contribute to a traditional 401k, you generally can’t deduct a traditional IRA contribution, so a Roth IRA is clearly the better choice. But your ability to invest in a Roth IRA starts to get phased out at an annual income $118,000. So, if you’re a high-income earner, a Roth might be off limits.
Because of all the quirks in the tax code, a Roth won’t work for everyone. But under the right circumstances, a Roth can be a really solid addition to your financial plan.
Ways to Make Money in the Market in 2017: #9: Max Out Your Health Savings Account
OK, let’s say you’ve followed my advice and have already maxed out your 401k plan and any IRA or Roth IRA accounts you qualify for. Well, there are a still a few smart ways you can invest while also lowering your tax bill.
If you have a high-deductible health insurance plan (and let’s face it, with health insurance costs what they are these days, it usually makes sense to go that route), then you can often pair that insurance plan with a Health Savings Account (HSA).
If you have a family health insurance plan, you can contribute up to $6,750, which is fully tax-deductible so long as any withdrawals are used for qualifying medical expenses. But no one ever said you have to withdraw the money. Personally, I pay my medical expenses out of pocket and invest my HSA funds, essentially using the HSA as an “extra” IRA. If I have a major medical emergency I need to pay for, the money is there to use. Otherwise, it just sits in the account and compounds.
I should be clear that HSAs are not IRAs. They are distinct account types with different withdrawal rules. IRA funds can be withdrawn penalty-free at age 59½, whereas HSA funds cannot be withdrawn penalty-free for anything other than medical expenses until age 65. But if you’re looking for an innovative way to stash away more investment cash tax-free, an HSA account might make all the sense in the world.
Ways to Make Money in the Market in 2017: #10: Be Tax-Smart
Taxes are the biggest single frictional expense for most investors … and one of the reasons that low-cost indexing often performs better over time. If you haven’t to give 20%, 30% or even more of your investing profits to Uncle Sam, then your wealth will compound a lot more slowly over time.
So, to the extent you can, arrange your finances in the most tax-efficient way possible. Try to own assets that are taxed the most unfavorably, such as stocks you intend to hold for less than a year or bonds, in an IRA, 401k or other tax-deferred account. More tax-efficient holdings, such as index funds or stocks you intend to hold for years, can be held in regular taxable accounts.
Don’t get lazy here. I can’t tell you how many times I’ve seen investors get taken to the cleaners because they failed to make efficient use of the tax shelters they’re already implementing.
Yes, it might take you an hour or two to rearrange your portfolio and might cost you a couple bucks in trading commissions. But for years or even decades of tax savings, it’s worth it.
Charles Lewis Sizemore, CFA is the principal of Sizemore Capital Management, a Dallas-based investments firm. As of this writing, he was long ETE, KMI and VNQ.