In response to a previous post on 401k allocations, one of my readers, Jason asked if the author of a website I mentioned was suggesting avoiding stock allocation altogether. I do not know if that was Rob Bennett's point - in my reading, I didn't necessarily get that impression. But I do know a few things I'd consider.
The first is Benjamin Graham's counsel. Graham is the father of value investing, whose followers include a laundry list of super-investors including Warren Buffett (the world's third richest man), the Schlosses, the folks and Tweedy Browne, Seth Klarman and many others. Graham, in his book The Intelligent Investor, a classic investing text, ranted against paying too much for stocks and poor performance that ensued. And yet, Graham acknowledged that there was a significant element of performance that may not be captured purely by valuations, and that because of market action, it might not be desirable for an investor to stay out of markets until the next bear market. His preference was instead to reflect those inflated prices in an adjustment in equity allocation, with a 50-50 stock-bond mix in normal times, and going down as low as 25% in either asset when it was inflated.
This is precisely the tactical asset allocation many institutional investors pursue. The best, in my mind, is Jeremy Grantham of GMO. Grantham's commentaries, available for free with registration, are a must-read. In his latest piece, he points to a global bubble in every kind of asset, and GMO's own 7-year forecasts predict that based on average conditions, we can expect poor returns from our stocks, bonds, real estate, whatever. And yet there's enough variability that you wouldn't want to sit on cash. While that risk profile would justify increasing allocations to near-cash instruments, (i.e. money-market funds) yielding over 5%, a 100% allocation would be a mistake!
Also, even within the stock market, there might be reasonable investments. The one promising asset Grantham finds is "high quality" stocks. This is consistent with the opinion of others like John Hussman, who points out that quality stocks are cheap relative to garbage. He points out that the median P/E of the largest 50 stocks in the S&P 500 is 17, down from 35 in 2000, while that of the smallest 50 stocks in that index is 20, up from 10 in 2000. So people are paying more for riskiest assets than stable giants. By the way, the median P/E on the small cap universe is somewhere around 35, if I remember correctly (source forgotten).
So what's an investor to do? Well, if you're an active investor, you could reduce your stock allocation, keep your bond durations relatively short (the US bond market is going to see some blood), and focus on a bottoms-up stock picking. If you're a passive investor, focus on cutting your stock allocations, increase your short-term allocations, and hoard some cash. Sprinkle in TIPS or I-bonds. Rebalance if you haven't been doing it!
Oh, and either way, maybe pay off your debt - that can give you a guaranteed "rate of return" of anywhere from 6-9% for your mortgage, to 10-20% for credit card debt.
UPDATE: COMMENTING CLOSED This is a first for me, but as I've followed this debate, and glanced at other forums where this debate has continued, I've decided that most of the quality information has been revealed in the post and comments so far, and we're getting a combination of regurgitation of the same facts and personal attacks. So I've decided to close comments on this post. This isn't intended as censorship or bias - simply a decision to prevent this blog from getting hijacked by a rather vitriolic battle I've seen at other forums. Thank you all for your participation - heaven knows I haven't had 11 comments on too many other posts before!