Today I was reading an interesting article in the WSJ describing the increased risk-taking that many retirees and near-retirees are taking with their investment portfolios.
For instance, “nearly half of Vanguard 401(k) investors actively managing their money and over age 55 held more than 70% of their portfolios in stocks. In 2011, 38% did so. At Fidelity Investments, nearly four in 10 investors ages 65 to 69 hold about two-thirds of their portfolios in stocks.”
It is very understandable that retirees have made these investment decisions. Stocks have been a great place to invest since 2009, after being a terrible place to invest from 2000-2008. The Federal Reserve’s zero interest rate policies made bonds highly unattractive alternatives. Inflationary pressures made cash a losing proposition, so many investors felt that stocks were the only game in town. However, things have changed a lot over the last year. With interest rates having rapidly increased, bonds have become materially more attractive investments. As we’ve mentioned before, there are a number of quality bonds yielding between 7-13% per annum, which I believe are likely to outperform the overvalued equity indices over the next decade, with materially less risk. Short-term government bonds are yielding well over 5%, which is over 70x what they were paying just a few years ago.
The stock market is more concentrated than ever and the MegaCap stock rally has overshadowed underlying weakness in much of the market. Now those MegaCap stocks are trading at nearly double the valuation of the rest of the market. Yes, these are good businesses, but this type of concentration and extended relative valuations have tended to appear during equity market bubbles and I believe we are seeing that once again. It isn’t necessary to take so much risk when alternative such as bonds, or quality high dividend-paying stocks are offering such fantastic values.
While the recent stock market rally may have investors feeling more confident and willing to take risks, history has shown that the combination of high valuations, market concentration, and bullish sentiment can be a recipe for poor future returns. For example, between March 2000 and May 2000, the Nasdaq plunged by 40% peak to trough. Then, from May through August of 2000, the Nasdaq rallied by a stellar 43%, bringing the index to just 14% of its all-time high. However, the good times did not last, and the Nasdaq proceeded to decline by a horrifying 80%. I’m not saying that will happen again, but I do think we are in the midst of a bubble once again and many are taking unnecessary risks that simply aren’t worth it given the alternative options available now. As always, we will continue to take a business approach to investing and try to maximize risk-adjusted returns over the long-term. I think we are in a good position, and we continue to find attractive opportunities.