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Are you a conservative, long-term investor concerned about an impending correction? Yes? Your priorities should be as follows:
Understand that the global stock market surge of the past year or two has pushed returns well above their long-term averages:
Data from investment dealer Edward Jones shows that U.S. large-cap stocks had a return of 32.4 per cent last year, compared to an annualized five-year gain of almost 18 per cent. That 18-per-cent number itself has been inflated by the strong recent results, but it still serves to show that the market's 2013 returns are way beyond the usual.
Understand that the markets can still move higher:
Edward Jones data shows that for the S&P 500 and MSCI EAFE indexes, there were 12 years of stock market returns greater than 20 per cent from 1970 through 2013. The average return in the year after those gains was between 16 and 17 per cent. For both indexes, stocks made money 75 per cent of the time in the year following a gain of 20 per cent or more.
Hold bonds, but get real about potential returns:
Edward Jones data shows that bonds have been roughly 50 per cent as volatile as stocks since 1960. That's why a bond component makes sense in your portfolio. However, bond returns will be constrained by an expected rising rate trend in the years ahead. Jones's numbers show bonds averaged returns of 3.9 per cent during the rate run-up from 1956 to 1981. As rates fell over the next 30 years or so, bonds averaged returns of 11.1 per cent. Bonds showed their vulnerability to rising rates by falling 1.3 per cent on a total return basis last year.
Rebalance:
Edward Jones recommends up to a 35 per cent weighting in global investments, which you can divide evenly between the United States and the world beyond North America. The firm suggests reducing holdings in financials and materials and instead looking at technology, health-care and consumer staples. Given the Canadian market's deficiencies in these three sectors, you'll want to look globally to add to them.
Trim your high flyers:
Jones says current valuations for U.S. small-cap stocks and high-yield bonds look "relatively unattractive."
Rob Carrick