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Presidential election years usually cheer stock investors. The S&P 500 has returned more than 22%, on average, during election years since World War II. But don't get excited for 2012. Those past returns are from too small a sample to draw conclusions about the future. And the lack of a solid explanation for how elections affect returns suggests they don't.
Besides, the 2012 election may only remind investors about political bickering that has damaged their confidence to begin with.
Europe has somewhat more at stake than America next year. Leaders there will decide whether the euro zone survives, and by extension, whether governments default, banks fail and trade takes a hit it can ill afford.
It's enough to make an investor want to clutch cash. They're doing just that, according to an August survey by MFS, a mutual fund firm. More than half of investors say they fear a major drop in the stock market over the next year. Also, more than half say they worry about inflation eating into their savings.
One of those two outcomes is a sure thing. The last reading on inflation was 3.5% over the past year. Money market accounts pay 0.5%, according to Bankrate.com (and plenty of them pay next to nothing). One way to predict the rate of inflation over the next decade is to subtract the yield on 10-year inflation-protected Treasury notes (about zero) from the yield on the 10-year ordinary Treasurys (about 2%). If inflation indeed is 2% a year over the next decade and an investor collects only 0.5% a year, he will end up 14% poorer--before subtracting for taxes.
Few investors expect to hold cash for a decade. Many are probably waiting for the next potential crisis to blow over. But when is the last time there wasn't a crisis on the horizon?
Now is a good time for the under-invested to begin wading back into the market. The place to start is with stocks. S&P 500 dividend yield is a whisker away from topping the 10-year Treasury yield. It has done so a few times in recent years. Before that, it hadn't done so since the late 1950s.
That alone doesn't make stocks a bargain, but it does make them look like a better deal than high-grade bonds. Scott Schermerhorn, CEO of Concord, N.H.-based Granite Investment Advisors, favors blue chip stocks like Johnson & Johnson (JNJ), Lockheed Martin (LMT), Kraft (KFT), McDonald's (MCD) and Royal Dutch Shell (RDS.A), among others. What his favorites have in common, he says, is that their shares pay more than their three- to five-year bonds--about 2 percentage points more, on average.
Keep in mind that dividends tend to grow over time, whereas most bond payments do not. For that reason, bond investors usually demand higher yields. Today's stock investors can easily beat bond yields, and there's reason to believe their payments will rise in coming years. S&P 500 funds are paying out a historic low percentage of their profits as dividends.
For investors who don't buy individual stocks, a low-cost index fund like those offered by Vanguard, Fidelity and Charles Schwab will do just fine. For those who have no idea how much to put in stocks, here are two rough guidelines to start with. The first is to invest your age as a percentage in stocks (but what matters more than age is how soon you might need the money). The second is to not have less than 25% or more than 75% in stocks, as Benjamin Graham long ago advised.
Money that doesn't go into stocks should go to other asset classes, chiefly bonds, but also real estate and other investments. Investors in 401(k) accounts will be constrained by what's on offer, of course. And with bond yields so low, it's more important than ever to keep fund expenses low. Below 0.25% a year is OK. Far below it is best.
Ultra-low yields might tempt some investors to skip bonds altogether, but that's a mistake. True, yields move in the opposite direction of prices, so unusually low yields imply unusually high prices. But consider two things. First, low yields can move lower. Japan's 10-year government bonds pay half what America's pay. Second, some bonds pay much more than Treasurys. Ones rated Baa by Moody's ("moderate credit risk") pay around 5.3%. A diversified fund of such bonds can reduce their risk.
These investments can lose value, of course. There's nothing wrong with investors buying into them little by little rather than all at once.
One of the only truly safe things to do with money is to spend it right away on something necessary. (On that note, houses look attractive in some markets--see "It's Time to Buy That House"). Those who have more money than they need are better off than those who don't. But investing is a difficult task now, because all of the choices seem flawed, and 2012 looks fraught with risk. However, sitting in all cash and waiting for risk to go away isn't a plan. Right now it's a slow savings burn. For investors who've waited too long for the perfect moment to get back into the market, that moment isn't coming. It's time to stop waiting.
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