These are confusing days for investors. On one hand, the major stock market indexesusually pretty good indicators of the economyhave hit record highs this year. On the other, we hear about how anemic this economic recovery has been. Who can blame investors for scratching their heads? Here at Wells Fargo, weve identified 10 issues we feel investors should know. Here they are, along with brief descriptions of their importance.
Corporate America is still strong. Although its true the recovery has been frustratingly slow for the most part, it appears corporate America has figured out how to generate profits in this slow growth/low inflation environment by becoming leaner and more efficient in recent years. These efforts have paid off and, as a result, corporate earnings have hit record highs this year.
Stock prices appear in line with earnings. Stocks have reached record highs just as corporate earnings have hit new record levels. Going back to 1986, the median price-to-earnings ratio for the S&P 500 was 16.7. As of the end of this years second quarter, the P/E for the S&P 500 was only slightly above that, which suggests stock prices are in line with corporate earnings.
Most investors results fall short of the markets. It seems many investors believe the key to success can be found in how they respond to day-to-day market activity. Unfortunately, studies have shown most investors actual results fall substantially short of the overall market. What are they doing wrong? Historically, one mistake many investors have made has been to allow their emotions to cloud their decision-making. For example, they have panicked and sold when the market declined and then were too slow to get back into the market in time to participate in its recovery. As a result, their returns have tended to lag the markets performance.
International investing deserves another look. Many Americans portfolios have a home biastheyre weighted heavily in domestic stocks and bonds.
While theres nothing wrong with that to an extent, we believe investors who are home alone (lacking any exposure at all to international investments) may be missing out on an opportunity to improve their portfolios returns while helping manage risk.
When the U.S. markets decline, investments in other countries dont necessarily follow suit. They may remain stable or actually increase in value. Thats one reason why we believe investors should consider diversifying to include international investments in their portfolios.
Of course, there are some risks in foreign investing that we dont see with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened when investing in emerging markets.
The volatility of stocks is likely to increase. Although we all remember the stock market volatility of a few years ago, things have been relatively calm more recently. In fact, its been calm for so long that we believe investors should be concerned about complacency in markets.
Although we dont foresee a sharp increase in volatility, we do expect it to move back toward its historical average. As a result, we think this is a good time for investors to review their portfolios to help ensure complacency hasnt lured them into assuming too much risk.
Fixed-income carries more risk than it did in the past. Given the current low-interest-rate environment and prospects for increasing rates in the future, fixed income may now carry more risk than investors realize. In fact, if long-term rates go up as little as one percentage point, the negative impact on bond prices could result in fixed income investors seeing their total returns dip into negative territory. Bond prices fluctuate inversely to changes in interest rates.
Therefore, a general rise in interest rates can result in the decline in the value of your investment. We believe investors should look carefully at how much of their portfolios theyre holding in fixed income and consider making adjustments now before rates go up.
Cost of health care in retirement may come as a surprise. According to the U.S. Bureau of Labor Statistics Consumer Expenditure Survey, between 6% and 7% of all consumers total expenses were dedicated to health care in 2012.
These figures are almost double for retirees, reaching between 11% and 15% of total expenses for people over age 65. As a result, its important for Americans to plan while theyre working to help increase the possibility theyll have enough saved to afford health care in retirement.
Everyone is responsible for his or her own retirement. Few Americans can still expect to have a defined benefit plan funded by their employer to help pay their retirement expenses. Instead, the majority will have to rely on what they contribute to defined contribution plans, such as a 401(k) or 403(b), to fund retirement. That means retirement planning is now more important than ever.
Asset allocation can help drive performance. Rather than attempting to time the market, investors should consider having an investment plan with an asset allocation designed to help them work toward their long-term goals with a level of risk theyre comfortable with. Although there are no guarantees, especially in a declining market, asset allocation can help drive a portfolios performance over time.
Saving regularly may help investors reach their goals. By starting early and saving regularly, investors can help make time an ally in working toward their financial goals. All it takes is planning and consistency.
Gary Thayer is chief macro strategist at Wells Fargo.