Thousands of investors sat on the sidelines during the stock market's rally and now have to decide whether getting back into stocks is the right move or if the market is about to go down again.
This article published with permission from InvestmentU.com.
More than 2,000 years ago, the Greek sage and philosopher Epictetus counseled, “It is impossible for anyone to begin to learn what he thinks he already knows.”
Nowhere is this truer than in the stock market. You need only ask the many thousands of investors who have sat out a historic rally — the market has doubled from its lows years ago — because they just stock prices were only going to go lower.
That mindset has proved to be an expensive one. Yet these individuals now face another test.
If they jump into stocks today, having already missed one enormous move, they risk being in for the next leg down. That would hurt. On the other hand, if they continue to sit on the sidelines — earning next to nothing in bonds or cash — the market may well power higher and leave them with an even more extreme choice in the weeks and months ahead.
What is the prudent investor to do?
They rise and they fall
The first is to understand the error of your ways. Every market timer believes that if he sits patiently on the sidelines, he will get a better opportunity to buy stocks at lower prices.
And they often do. Unfortunately, they generally get to feeling so good about missing the downdraft that they convince themselves that the market will keep falling.
And, again, it often does. Until, of course, it doesn’t.
As the market climbs, they begin to rationalize that this is just “a bear market rally” or “a dead-cat bounce.” Until it becomes obvious that the train left the station, and they’re still standing on the platform.
Cash is not king, but stocks might be
Warren Buffett’s mentor Benjamin Graham once said that no investor should have more than 75% or less than 25% of his money in stocks.
That’s a good rule of thumb. Seventy-five percent keeps you from getting overly enthused when times are good. And 25% keeps you from throwing in the towel when times are bad.
But what do you do now if you’re one of those who have played it too cautious until now and are fed up with your negative real returns in Treasury bonds or cash?
First, stop justifying what you’ve done and get off the dime. Start committing money to high-quality stocks in a gradual way. After all, if you shift a big percentage of your portfolio into stocks right now, you could regret it. And if you remain in cash, you could regret that, too.
So hedge yourself. Start moving money into stocks at regular intervals, being sure to keep buying if the market dips so you get better entry prices.
An easy way to start investing
A conservative place to start would be the Vanguard High Dividend Yield ETF (NYSE: VYM). True, it currently yields just 2.9%, but that’s still 50% more than 10-year Treasuries are paying and 50 times as much as the average money market fund.
Even if stocks go nowhere over the next 10 years — highly unlikely given the decade we just had — you’d still be better off in this fund than in a bond or money market fund.
There are a ton of reasons to put off making this move from the state of the economy to the size of the deficit. But that’s just the kind of thinking that got you stuck on the sidelines.
Look at the bright side. Inflation and interest rates are low. We’ve had five straight months of declines in the jobless rate. The ECB has extended three-year, low-cost loans to European banks. The Greek parliament has voted to actually cut spending. And we’re in a period of all-time record corporate profits.
So cast off. As the great nineteenth-century theologian William Shedd pointed out, “A ship in harbor is safe, but that is not what ships are built for.”
Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.