It’s been a strange year in financial markets. Bonds are in the midst of a record three-year drawdown, the S&P 500 is carried by just seven companies, small and mid-cap stocks lag, gold is breaking through the $2k barrier and Bitcoin is the number one performing asset. The bag is more mixed than trick or treat in a trailer park.
Most news outlets focus reporting on the major US large cap indexes, such as the S&P 500 and the DOW Industrial Average. These indexes only represent a narrow portion of investable assets, however, and you will have an incomplete picture of market conditions if this is all you look at.
As famed investor Warren Buffet once suggested to us commoners, be “fearful when others are greedy and greedy when others are fearful”. If you were to put a finger in the air and test average investor sentiment, it would be decidedly bearish. This is evident in the risk-off trading we see in the flight from higher volatility mid and small cap stocks to large cap stocks with massive balance sheets (i.e. Apple, Amazon, Microsoft, etc).
While you’re not getting any good deals on the mega cap growth names we know and love, there are plenty of bargains to be found. Investors can find valuation discounts I haven’t seen since the 2008 financial crisis in some areas, particularly in the small cap value space. Another example, while the S&P 500 is up a little over 10% year to date, the utilities sector is down -13.48%!
Before you jump in like a 5-year-old into a cold pool, let’s acknowledge some realities. First, the possibility of a recession and further market deterioration is quite real. Second, even absent the risk of recession, the market can be fickle, moving on rumors and technical data that has nothing to do with fundamental economics.
While it’s perfectly reasonable to deploy cash as a lump sum and walk away successful as a long-term investor, the initial shock if you jump in at the wrong time could leave you with a case of shrinkage. The more comfortable way to invest risk-off capital into areas of opportunity is through a Dollar Cost Average (DCA) program.
In last week’s newsletter, I demonstrated why I’m bullish on equities and that I believe we’re close to the cycle bottom. I base this on more than just a feeling, but volatility spikes trigger abruptly and can be emotionally driven. I cannot predict what direction this will go in anymore than a teenager’s mood after school.
Dollar Cost Averaging means investing incrementally over a pre-defined period. The most typical periods are 3-months and 6-months. The option that is right for you depends on how aggressive you want to be. I personally like the 6-month period, even though it’s a bit sleepier.
Implementation involves dividing your cash into tranches, say monthly, then scheduling an automatic purchase into the equity portfolio of your choice on fixed dates. I like to couple this strategy with a bond ladder to leverage the attractive yields on short-term bonds and CDs today. As of this writing, the average 6-month CD is between 5.3% and 5.5%, depending on the bank.
Here’s what that looks like.
I like to use CDs and Treasuries to implement the DCA strategy because of the minimal inherent risk. While you could use other fixed income securities to achieve a slightly better yield, the increased risk is not worth it, in my opinion.
Lastly, if the market does not correct, the DCA program would reduce your returns relative to a lump sum strategy. Given that markets mostly move up over time, a DCA program is not designed to enhance returns. Rather, it’s meant to smooth out mood swing shocks that can leave you in a state of buyer’s remorse.
Kids do have more fun in pools, but grown-ups are less frequently saved by lifeguards. Dollar cost average and don’t risk capital you plan to spend within five years.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to effect some of the strategies. Investing involves risks including possible loss of principal.
Securities offered through LPL Financial LLC. Member FINRA/SIPC. Advisory Services offered by National Wealth Management Group LLC, an SEC Registered Investment Advisory and separate entity from LPL Financial LLC.