Investing In an Overpriced Stock Market

Tim Hayes AIF®, CRPS®, AWMA®, CFS®, APMA®, CAS®

It Is Not Your Fault You Retired When the Stock Market is High and Interest Rates Are Low

Tim Hayes AIF®, CRPS®, AWMA®, CFS®, APMA®, CAS®

You just retired. Along with a great career, you have built up a substantial 401(k) balance. It took a while, but you got the hang of investing in equities, never comfortable with the ups and downs, but always focusing on long-term growth.

However, now you need income, not growth. Over the years, you owned some bonds with mixed success. Moreover, unlike your foray into equity investments, this time, you cannot afford on-the-job training. You need the income now. Plus, you have less time to recover from any mistakes.

With Interest Rates Low, Where Do You Go for Income?

The Department of Labor’s fiduciary rule might have resulted in more people keeping 401(k)s with former employers. However, on March 15, 2018, the Fifth Circuit Court of Appeals ruled that the Department of Labor overstepped its bounds in creating the so-called fiduciary rule, parts of which went into effect last year.

The 2019 retirement SECURE Act makes it easier for employers to offer annuities in their 401(k) plans. But with the economic recession brought on by the pandemic, most employers have probably yet to adjust their plans.

So, the Question Remains—Can You Get the Income You Need From Your Plan?

Many employers still steer their employees’ 401(k) choices toward stock funds to grow their accounts, rather than bond funds or annuities to distribute the accounts.

Even if your plan offers sufficient bond funds, today, with the ten-year U.S. Treasury Bond yielding just .5%, bonds hardly seem to be the place to go for income, even though, government bonds have provided investors with an excellent total return so far this year.

For example, the Barclays Aggregate Bond Index is up 5.4% for the year. Total return combines the interest rate with the bond’s change in price: bonds go up in value when interest rates fall.

Diving Into the Stock Market

Many retirees who are frustrated by low rates have put money that was earmarked for bonds into stocks, hoping the dividends plus the growth will provide sufficient income.

Even with the coronavirus-induced recession, the stock market, as measured by CAPE or the Q Ratio, is still anywhere from 80–100% overvalued. This does not mean it cannot continue to increase; it can, and it has. (It was more overpriced during the late ’90s Internet boom and the Roaring ’20s than it is today.)

High stock prices can exacerbate the problem with a stock-centric retirement portfolio. If the market drops and you withdraw principal as income, that money is no longer in your portfolio if the market rebounds.

The Financial Services Industry Has Adapted to This Low–Interest–Rate Environment

It has done so by building products for it, some of which provide you with income guarantees. But, they come with restrictions on withdrawing your principal, as well as somewhat confusing terms and conditions.

Other products offer a higher yield, but no guarantees of how much of your investment will be returned. Many of them also lack daily pricing, making it impossible to know the value of your account on any given day.

In This Turbulent and Unfocused Market, Going It Alone Can Be Unnerving

Those with questions should be wary of talk-show advice, whether it be on television or the radio.

Understanding interest rates, bonds, and dividend stock investing along with other transition products can be challenging, if not confusing.

With an upcoming election, talk of a second wave of the coronavirus, and so much uncertainty worldwide, now may be the best time to take control of your financial future.

As with most things in life, the first step is often difficult, but securing sound financial advice shouldn’t be left until it’s too late.

Finding a licensed and knowledgeable resource: It’s the best financial advice you’ll ever receive.

These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only and should not be construed or acted upon as individualized investment advice.

Investing In Foreign Stocks and Bonds

Tim Hayes AIF®, CRPS®, AWMA®, CFS®, APMA®, CAS®

Because different countries have different currencies, overseas travel is usually more complicated than domestic travel. Likewise, overseas investing is more complicated than domestic investing. However, just as foreign travel adds diversity to your travel experiences, so foreign assets add diversification to your portfolio.

With a gross domestic product (GDP) of over $20 trillion, the United States has, by far, the world’s largest economy. (China has the second-largest, with a GDP of $13 trillion.) Moreover, 54% of the world’s stocks and 39% of the world’s bonds are based in the U.S.

Also, the correlations between the U.S. and non-U.S. stock markets have more than doubled over the last 25 years, meaning fewer benefits from diversification, as these markets now tend to move in tandem.

Diversification and Investment Portfolio Design

Therefore, it is understandable why individuals living in the world’s most dominant country prefer to invest here, given their allegiance to the so-called home team. This bias, however, may prevent individuals from realizing the benefits international stocks and bonds would provide to their portfolios.

According to a 2014 study by Vanguard, the average investor’s portfolio contains 27% foreign stocks.[i] If the foreign stock percentage seems high, remember that the U.S. holds only half of the world’s total stock market value. This means that 50% of the world’s stock market value resides outside of the U.S.

A second 2014 Vanguard study, this one focusing on bonds, confirmed what I see in my practice: most U.S. investors have very little exposure to international bonds[ii]—even though 60% of all world bonds now reside outside of the U.S.[iii]

When individuals invest in overseas stocks or bonds, they rub up against the world’s largest market: the currency market. According to the Bank for International Settlements, foreign-exchange trading volume averages $6.6 trillion per day, while the entire U.S stock market trades about $191 billion per day.[iv]

Active vs Passive Investing

Some investors hedge their currency risk by locking in times and prices at which they sell or purchase a currency. But hedging costs money. An investor must pay a fee to a counter-party—an institutional investor, corporation, government, bank, or currency speculator—for the right to buy currency from them or sell a currency.

Investors who enjoy owning individual stocks but want the added diversification of foreign stocks can incorporate American Depositary Receipts (ADRs) into their portfolios. ADRs are international stocks that U.S. investors purchase with dollars and from which they receive their dividends in dollars. However, currency changes affect the performance of ADRs.

More than 2,000 ADRs from more than 70 countries now trade in the U.S.,[v] including ADRs from such well-known international companies as Toyota, Nestle, GlaxoSmithKline, Deutsche Bank, and Sanofi.[vi]

There are many ways for individual investors to get exposure to foreign stocks or bonds—and, if you believe the Vanguard studies, the average investor has done an excellent job diversifying into international stocks. However, those same investors have not done the same with foreign bonds.

Of course, there is no such thing as an average investor, and everyone’s asset allocation and diversification depend on that individual’s specific goals and risk tolerance. However, most investors would benefit by having a percentage of their portfolio allocated to overseas stocks and bonds.

With 40% of the profits of the firms listed in the S&P 500 stock index now coming from overseas sales, some financial professionals believe that investors get plenty of diversification by owning stocks of U.S. multinationals. However, this theory fails to explain why bond investors have most of their portfolios in U.S. bonds.

[i] Christopher B. Philips, CFA, “Global equities: Balancing home bias and diversification,” Vanguard.com, February 2014. Retrieved from http://www.vanguard.com/pdf/ISGGEB.pdf

[ii] Christopher B. Philips, CFA, et al., “Global fixed income: Considerations for U.S. investors,” Vangaurd.com, February 2014. Retrieved from http://www.vanguard.com/pdf/icrifi.pdf

[iii] QVM Group, LLC http://qvmgroup.com/invest/2012/04/02/world-capital-markets-size-of-global-stock-and-bond-markets/

[iv] Bank for International Settlements website, http://www.bis.org/

[v] U.S. Securities and Exchange Commission Office of Investor Education and Advocacy, “Investor Bulletin: American Depositary Receipts,” August 2012, www.investor.gov. Retrieved from http://www.sec.gov/investor/alerts/adr-bulletin.pdf

[vi] “Equity Investor Marketplace,” UBS, http://eqi.ibb.ubs.com/equityinvestor/en/UBS/underlyings.html

These are the opinions of Tim Hayes and not necessarily those of Cambridge. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.