How to invest in today's market
While depressed stock prices present lots of opportunity, your long-term investing strategy shouldn't change with the times.
NEW YORK (Money) -- Question: I believe that along with a recession comes a great opportunity to invest and make significant long-term gains. I'm under 30, I contribute to my 401(k) plan and I'm willing to take risks. What are my best options in today's market? --Lyle, Fort Lauderdale, Florida
Answer: Hey, I'm with you. Although they can be painful, recessions not only wring a lot of the excesses out of the economy and markets, they also set the stage for people who invest in stocks that have been pummeled to potentially earn some impressive gains.
For example, if you had invested in stocks in December, 1974, which was the trough of the severe 1973-1975 recession, you would have earned a 37% return over the next year, a 16% annualized gain over three years and 15% annualized for the five years ending in December, 1979. That's a huge increase over stocks' compound annual return of roughly 10% since the mid-1920s.
That said, I'm not a big believer in trying to exploit the economy's recovery for even bigger gains by targeting your investing toward specific industries, sectors or other niches.
If you're really interested in building a nest egg over the course of your career that will sustain you in retirement, I think the best course is to adhere pretty much to the same investing strategy today that you would (or should) employ at any other time -- that is, maintain a broadly diversified blend of different types of stocks or stock funds, and throw in some bonds or bond funds for stability.
I realize that this puts me at odds with much of the investing world -- both financial firms and the investment "punditocracy" that espouses its views in articles, blogs and cable TV appearances. Much of what you hear or read nowadays consists of people trying to predict what sorts of stocks or funds might deliver outsize gains as we emerge from recession.
Indeed, recent research from Wasatch Funds makes the case that small-cap stocks are the place to be when the economy is coming out of recession. The report notes that small-caps have outperformed large-caps by almost a two-to-one margin (34% vs. 18%) in the year following the last nine recessions.
And a new study by Russell Investments says that value stocks typically beat growth shares in the early periods of an economic expansion, and that this tendency is strongest in small-caps.
I have no reason to doubt the information in either report. But having read them, I'm not going to run out and load up on small company stocks, value shares or, in an attempt to get the best of both worlds, small-company value stocks.
Why? Well, it's easy when you're looking backward to know when you should have gotten into small-caps or any other sector. After all, with the benefit of hindsight you know exactly when past recessions ended. But we don't know when this recession will end (or, for that matter, whether it already has). So when, exactly, do you move into small caps? Now? A month from now? Two months? Get in too early -- or too late -- and the extra gains might be smaller or might not materialize at all.
Besides, it's not as if all economic and market cycles play out exactly the same. In fact, the Russell report notes that the 2001 recession was an anomaly compared to the other three it examined, and thus resulted in a very different pattern of small-cap growth vs. value returns.
Given the stock market's strong rebound (so far at least) from its March lows, it's understandable that many people are beginning to regain a bit of confidence about investing in stocks. In general, that's a good thing.
But let's not get overly exuberant here. If anything, the events of the past year or so have shown that we're not exactly savants when it comes to predicting short-term investment performance.
So while I'm still confident in stocks' ability to deliver robust gains over the long-term -- especially when you buy them at depressed levels in the wake of a crash -- I'm not inclined to make big bets that a particular sector of the market will outperform another over a relatively short period of time. I'm just not convinced that investors -- pros or regular Joes -- are prescient enough to make such calls and nimble enough to get in and out at the right time.
Bottom line: If you want to capitalize on this recession to boost the eventual value of your 401(k), contribute as much as you can and maintain a diversified mix of stocks and bonds that's appropriate for your age and risk tolerance.
Given your age, that will probably mean investing between 80% and 90% of your 401(k)'s assets in stocks. Believe me, that's plenty enough risk. You don't need to compound it by engaging in a guessing game about which segment of the market might deliver the biggest gains in the next year or two.
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