With the stock market seeming to hit a new high every month or so, it's tempting for those not in the market to take the plunge. But those already in the market face a tougher question: When to get out?
Over the last 15 years the Standard & Poor's index of 500 companies has yielded close to 1,000%, an annual return of some 17.24%. Clearly, this pace of growth is phenomenal, more than at any other time in history. Experts are calling it the result of a so-called "Goldilocks" economy Â— neither too hot from growing too fast and thereby creating inflation, nor too cold from the slower-paced growth associated with recessions. In short, it's just right. But for how much longer?
Financial advisors Ken and Daria Dolan believe that momentum is carrying the current stock market rather than company earnings, and warn the market could turn down at any moment.
Two Cases for Caution
According to the Dolans, the two most likely scenarios that could force the economy to turn on investors are inflation caused by a tight labor market or deflation as a result of problems in Asia. The most likely culprit is inflation, which they say tends to rise at least 6 months before unemployment bottoms. With unemployment at approximately 4.3% today, many economists think that a rise in inflation is not far off. When employers have to pay more to lure workers, those higher wages will be passed on to the consumer in the form of higher prices. Should prices rise even as little as 4%, this inflation could seriously impact the stock market.
Other economic experts believe that problems in Asian markets could inhibit growth of the U.S. economy by reducing the amount of goods purchased from the United States. Lower exports could reduce growth and subsequently impact the stock market.
In either case, the Dolans recommend investors adopt a defensive stance, and for those not in the stock market, consider resisting the urge to take the market plunge.
Defending Your Earnings
Here are some suggested strategies for reducing your risk:
Consider taking some profits off the table. This can happen one of two ways: Investors can take out their profits, and let their original stake continue to play in the marketplace. Alternatively, investors can withdraw their original stake, and let the profits ride. In either case, this move will help investors reduce their risk, with one caveat: At least one-fifth of the profit will be eaten up by capital gains taxes.
Once you've taken profits, if you still feel bullish, the Dolans suggest re-investing slowly, selecting companies you understand particularly well, or in mutual funds which match your investment aims. Smart tactics include investing in so-called "defensive" stocks which will likely have good yields, even in a downturning market.
One idea suggested by the Dolans is utility stocks and utility mutal funds because utilities afford the investor a potential "double play" -- reasonable dividend yields, now around 4% to 5%, as well as the possibility of a capital gain on the stock itself. Utilities tend to do well in a low interest rate environment because their business is capital intensive. Also, during an economic recession, people may cut back on the goods they buy, but they still have to pay the power bill.
Another potential haven is REITs, short for Real Estate Investment Trusts. These trusts, purchasable from brokers just like a stock investment, allow investors to get a piece of a company investing in real estate projects, ranging from rental properties to strip malls. Earnings are derived from rents on those properties. One advantage is that investors can play in the real estate market for just a few hundred dollars. REITs are also more liquid than real estate, because it's easier to sell a stock than a condo. REITs are attractive because of their yield. Over the past year they have yielded 6.8%, compared to the stock market average of 1.5%- 2%.
Other investment analysts suggest investing in computer services companies, rather than computer manufacturers. Because the year 2000 (Y2K) problem is likely to impact many computer systems in the U.S., it's likely computer service companies will have plenty of work on their hands, and the profits to prove it.
Stock market bears ought to consider a three-month Treasury bill. T-Bills are very secure investments, as they are guaranteed by the U.S. Government and are free from state and city taxes. Interested investors should check their telephone directory's blue pages under "U.S. Government - U.S. Treasury" for the nearest office, and request the "Treasury Direct" package to find out how to buy treasury securities direct from Uncle Sam. You can also buy T-Bills directly from the Treasury Department at http://www.publicdebt.treas.gov.
The average American carries a credit card balance of $7,000, and pays more than $500 annually in interest charges. Clearly, this is a money pit. If the interest on your credit cards is 15% and the yield on a stock is 2% you'd have to expect at least a 13% rise in the market to make it worth keeping the money in stocks rather than paying off your credit card debt. Until you pay off current debt, leave your cards at home and stick to a cash-only budget.
For more investing information, and a guide to using your computer to invest online, read CBS.com's Online Investment Guide
Written by Carolyn Libby and Sean Wolfe