Factoring in Market Conditions

Factoring in Market Conditions

When choosing your mix of investments, do not ignore current market realities. The U.S. stock market is trading at historic high valuations. Growth stocks (stocks of companies with fast-growing earnings including many new technology companies) are at particularly high valuations. But even "value" stocks (stocks of companies with steady earnings and substantial capital) are not cheap.

Until recent years, U.S. stocks were expected to return 10 percent a year long-term. Today investors expect returns of 15 percent and higher. Earnings growth averaged about 6 percent a year in the 1900s. Even in decades of high-productivity improvements, earnings growth never averaged as high as 10 percent a year. If we truly are in an era of a new Internet economy, it is still unlikely earnings will grow 15 percent a year. Yet if earnings do not grow that rapidly, it is hard to imagine why stocks deserve their current high valuations.

For catch-up investors, U.S. stocks are not the best place to put more than a third of their assets. Returns over the next 15 years are unlikely to match returns over the past 15 years. But at 50 with a 30-year life expectancy, for example, it is reasonable to use U.S. stocks in some portion of your retirement portfolio.

Look for Value

Within an expensive market, areas of good value exist. Income stocks -- stocks that pay large and secure dividends -- are widely available. Their large dividends will keep your portfolio growing even when markets correct. Financially-sound gas and electric utilities as well as REITs currently pay dividends between 5 percent and 10 percent a year with little danger of reduction. As dividends are subject to higher income tax rates versus the capital gains rate, these investments are best held in tax-deferred retirement saving accounts.

Foreign and emerging market stocks have been through periods of high valuation and many sell at reasonable levels. Also, look for values in the U.S. real estate market. Office buildings today can sell for less than they cost to build in the 1980s.

Catch-up investors would be wise to buy some foreign and emerging market stock funds as well as some real estate and REITs over the next fifteen years. While no combination of investments can be expected to return 15 percent over the next 30 years, a mix of U.S. stocks, foreign and emerging market stocks and real estate or REITs is likely to produce 10 percent to 12 percent over the next several decades.