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If you have some cash you're thinking of investing, it can be tempting to sit on the sidelines.
Bonds have been under pressure for months and show few signs of picking up. The U.S. stock market has been a superstar but has become one of the world's pricier markets, according to some valuation measures, and may be due for a pause.
Yet if you're investing for the long run — at least 10 years — there are still plenty of opportunities, according to the money managers, investment strategists and other experts we interviewed. Here's some perspective on today's market and a few ideas to consider, whether you're building a $100,000 portfolio or looking for some tactical moves to make.
Stocks have been surging lately, and it may be because the market is in a "Goldilocks sweet spot," according to Jurrien Timmer, co-manager of the Fidelity Global Strategies Fund (FDYSX).
The economy has been expanding at a modest clip, inflation has been subdued and the Federal Reserve's stimulus programs are providing support for financial markets, he noted in a recent report. "In my view, it has been the best of all worlds for stock investors," he said.
Still, markets are volatile and difficult to predict in the near term. And some investment strategists think stock and bond returns may come under pressure from here.
Historically, U.S. stock returns have averaged 9% a year while bonds have averaged 5%, according to Chris Brightman, head of investment management for Research Affiliates, an investment advisory firm in Newport Beach, Calif. For a traditional 60/40 portfolio of stocks and bonds, the result has been annual returns of 7% to 8% on average.
Yet from today's starting point, returns for U.S. bonds and stocks are likely to be below-average, in Brightman's view. He notes that the bond market now yields around 2.3%, for example, which means investors should conservatively expect bonds to return about 2.3% — less than half their historical average.
Stock returns come from a mix of dividends and earnings growth. In the 1940s and 50s, dividend yields of 7% and earnings growth averaging 4% generated market returns above 10%.
Today, the S&P 500 is yielding 2.1%. Assuming earnings grow at a 4% rate — slightly faster than long-term average economic growth — stocks are likely to return around 6% from here. That would translate to average returns of 4% to 5% for a 60/40 portfolio, Brightman says.
Granted, economic growth may pick up from a recent pace of 2.5%, propelling stocks higher. And even if the economy expands at its current pace, the market's momentum may push up stocks for some time.
Still, Brightman isn't optimistic that long-term returns for stocks and bonds will match or exceed their historical average. "From today's microscopic yields, the classic 60/40 portfolio is unlikely to deliver the returns that investors expect," he says.
Fortunately, investors may be able to enhance their returns by diversifying into other assets and rebalancing their portfolios. Broad diversification and systematically rebalancing can enhance returns by more than 1 percentage point over a 60/40 mix, without adding more risk, says Brightman.
For a long-term investor, he suggests a basket of 10 asset classes, allocating 10% to each area. Below is a sample portfolio that could work with a total investment of $100,000. The mix should be rebalanced back to the target allocations annually, he says.
The ETFs were selected based on our interviews with money managers and other research we conducted. Each ETF has its own set of risks and could decline sharply for various reasons.
|iShares MSCI USA Minimum Volatility ETF (USMV)
|PowerShares FTSE RAFI US 1500 Small-Mid Portfolio (PRFZ)
|PowerShares FTSE RAFI Developed Markets ex-U.S. Portfolio (PXF)
|PowerShares FTSE RAFI Emerging Markets Portfolio (PXH)
|Vanguard REIT ETF (VNQ)
|ELEMENTS Rogers International Commodity ETN (RJI)
|PowerShares Senior Loan Portfolio (BKLN)
|PIMCO 0-5 Year High Yield Corporate Bond Index ETF (HYS)
|iShares Emerging Markets Local Currency Bond ETF (LEMB)
|PIMCO 15+ Year U.S. TIPS Index ETF (LTPZ)
If you don't want to make major changes to your portfolio, there are plenty of other opportunities worth considering, experts say. How much to invest in each area depends on your overall asset mix, time horizon and other factors. As always, you should consult a financial adviser or do your own research before investing.
One area that looks attractive now is European stocks, according to Brian Singer, lead manager of the William Blair Macro Allocation Fund (WMCNX). Europe's economy is starting to grow again after a rough recession, and European stocks look cheaper than their U.S. counterparts, he explains.
"We'd say investors would be better served investing cash outside the U.S. and predominantly in European markets," he says.
Other strategists also like Europe-based stocks, noting they remain relatively inexpensive — even after a big climb.
"The valuation gap between Europe and the U.S. is so big we'd almost advocate closing your eyes and owning some European stocks," says Doug Ramsey, chief investment officer of The Leuthold Group, an investment management firm in Minneapolis.
The iShares Europe ETF (IEV) offers exposure to large-cap stocks in Europe, with nearly half its assets in Switzerland and Britain — two markets that weathered the recession better than many peers, according to Morningstar analyst Alex Bryan.
The ETF is a "suitable" core holding for investors who want "to take advantage of compelling valuations in Europe," he noted in a report. It has an annual expense ratio of 0.60% and yields 2.6%.
Key risks: Europe's economy could stumble if its debt crisis flares up again. The ETF has currency and local market risks.
Two European markets that look even more attractive are Italy and Spain, says William Blair's Singer.
Italy's political climate is stabilizing and the country is working through its debt issues, he says. Spain is also making progress, improving competitiveness and seeing some exports growth. Both markets look cheap as well, according to Singer.
The iShares MSCI Spain Capped ETF (EWP) and the iShares MSCI Italy Capped ETF (EWI) offer exposure to both regions. The ETFs have annual expense ratios of 0.50% and yield around 3%.
Key risks: The ETFs pose currency risk to U.S. investors and could fall on losses in local markets.
Emerging markets have their woes, from slowing growth in China to inflation in India and Brazil. Yet their problems are well-known in the investing world. Indeed, the MSCI Emerging Markets Index has returned an average of -0.33% over the last three years, vastly trailing more mature markets.
The upshot: Emerging markets now look inexpensive, according to the Minneapolis strategist Ramsey. They trade at 13.5 times "normalized" earnings over the past five years, a discount to the average P/E of 18, he says. Based on the same measure, the U.S. trades at 22 times earnings while Europe is at 16 times.
Ramsey doesn't expect a rebound overnight. Developed markets have been the strongest global performers in this rally, and market leaders historically hold their momentum throughout a bull market. Yet "emerging markets are setting themselves up for a leadership run in the next bull market," he says, and they look compelling if you have a 10-year time horizon.
The iShares MSCI Emerging Markets Index Fund (EEM) is one of the largest ETFs in the space and is "suitable as a core holding" for investors who want emerging market exposure, according to a report by Morningstar analyst Patricia Oey. It has an annual expense ratio of 0.68% and yields 1.8%.
Key risks: The ETF is volatile and entails currency and local market risks, among others.
While the U.S. may not be the cheapest market, some strategists still see opportunities among companies with healthy balance sheets and room for both share buybacks and dividend hikes.
Companies have been using high cash balances to return capital to shareholders through dividends and buybacks, boosting the "total yield" to investors, according to research from Fidelity investments.
Further, stocks with low payout ratios — the percentage of profits they pay in dividends — look cheaper than stocks with the highest payout ratios, according to a recent report from Fidelity.
Some strategists also view these types of stocks more favorably than high-yield sectors such as utilities and telecoms. "Dividend growth stocks trade at relatively better valuations than the high yielders," says Mebane Faber, chief investment officer of Cambria Investment Management in El Segundo, Calif.
Several ETFs focus on dividend growth, including the SPDR S&P Dividend ETF (SDY), WisdomTree LargeCap Dividend Fund (DLN) and iShares Dow Jones Select Dividend Index (DVY). Yields range from 2.3% for the SPDR ETF to 3.4% for the iShares fund. Annual expense ratios are all less than 0.50%.
Stocks in the SPDR ETF tend to be "boring, quality names," according to Morningstar analyst Samuel Lee. The iShares ETF focuses on more cyclical companies with higher yields, he noted in a report. The WisdomTree fund emphasizes large-cap value stocks screened for a mix of earnings and dividend payouts, among other measures.
Key risks: The ETFs could trail the market if their investing styles fall out of favor.
Daren Fonda is Senior Writer and Investing Columnist with Fidelity Interactive Content Services, a provider of objective investing content on Fidelity.com. He does not own any of the securities mentioned in this article.
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