by Alexander Green, Investment U Chief Investment Strategist
Monday, January 7, 2013: Issue #1942
More than two thousand 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 an historic rally – the market has doubled from its lows years ago – because they just knew 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, if 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.
Moving into Stocks at Regular Intervals
Warren Buffett’s mentor Benjamin Graham once said that no investor should have more than 75% of his money in stocks or less than 25%.
That’s a good rule of thumb. Seventy-five percent keeps you from getting overly enthused when times are good. And twenty-five percent keeps you from throwing in the towel when times are bad.
But what do you do now if you’re one of those who has 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 much 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. Economic output is now back where it was at its peak in 2007. Shale gas is creating a cheap, clean energy revolution. Corporate profits are at an all-time record. And so are corporate profit margins.
So cast off. As the great 19th-century theologian William Shedd pointed out, “A ship in harbor is safe, but that is not what ships are built for.”