This is an unusual market where stocks, preferreds, and bonds appear fully valued. It is even difficult to find many good opportunities in alternative investments such as real estate. Conservative investors have achieved above-average returns this year and I believe that this trend is unlikely to continue.
At the start of the year, I could buy a conservative preferred stock at a yield-to-call of 6%. This same preferred is now trading at a yield-to-call of 4%. There is no appreciation left in this security. Safe havens for investors to park cash for an above average yield is not without a higher degree of risk. The best tactic to invest in lofty markets is to dollar cost average and focus on the total return of the investment.
Dollar cost averaging is useful when it’s difficult to determine a good entry point into an investment. By investing a fixed amount of money in a consistent manner over time, there will be less regret of making a poor investment decision if markets suddenly drop. There is much debate whether dollar-cost averaging actually reduces risk. Vanguard research wrote a white paper in 2012 and concluded that dollar-cost averaging just means taking risk later. They wrote that investing a lump sum immediately to gain exposure to markets was the prudent action. Their research showed that on average, lump sum investing beat the dollar-cost averaging approach two-thirds of the time.
In my article last week, I wrote how the game rules are changing for asset allocation due to the manipulation of interest rates by central banks. There is close to a staggering $11 trillion dollars worth of bonds with negative interest rates overseas. I also believe that dollar-cost averaging might be the more prudent action than investing a lump sum. Taking some risk now and some risk later is a better tactic in this fully valued market.
It is also important to make a distinction between total return and income yield. Many bonds and dividend paying stocks are not compensating investors for the risk that they are taking. This lofty market also has many investors concentrating their portfolios on a high yield and not total return. Investors that are chasing yields will be at more risk when interest rates begin to rise.
Stocks can justify these valuations as along as the consumer keeps spending, oil prices stay low, and job growth remains strong. In this lofty market, I’m recommending to my clients with new money, that the best tactic would be to dollar-cost average and focus on total return.
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