It's probably time for a reality check as we approach what now looks like the 47th month of the bull market. The S&P 500 index was at a low of 676 on March 9, 2009 and closed at 1,470 last Monday. For anyone counting, that's a 117 percent increase. If you're a buy-and-hold investor who didn't freak out and bail out back in 2008, you can enjoy some smug satisfaction.
What happens next will be anyone's guess, but it's always comforting to know in advance that there has never been a 12-month period when the stock market didn't experience at least one downdraft of 10 percent or more.
Furthermore, the S&P 500 index cited above may have created skewed results that make it less ideal as a proxy for the entire stock market. Its dramatic low point in 2009 was influenced disproportionately by the once obscenely-profitable financial services sector that made up almost 40 percent of the entire value of the index by 2007. Bank failures had a larger than normal impact on what had traditionally been a cross section of all business sectors.
While the S&P 500, including re-invested dividends, made exactly nothing for the period ending Dec. 31, 2010, most investors during this so-called "lost decade" actually made 5 to 7 percent per year if they had diversified their investment allocation across a variety of mutual fund types. Companies across America actually made more money in 2008 than they made in 2007, but who noticed that in the face of the panic. Today, that stream of record profitability continues to have legs, but one factor looms as a cloud on the horizon.
Defense spending will be checked in the years to come, and the immediate impact of the fiscal cliff debate has manufacturers suddenly holding back on the purchase of new capital equipment. They are waiting until it becomes clear as to what form defense cuts will take.
I'm curious myself. Recently released classified information reveals that we have manufactured 75,000 atomic bombs since 1945, and our current stockpile costs $18 billion a year to maintain. We can probably cut back a bit in that department, and none of us would feel a loss.
On the other hand, funding for programs like Meals on Wheels and Head Start are also on the chopping block which most of us would agree is unfortunate. The nice thing about the latter proposed cuts, however, is that they won't adversely impact stock prices like cuts in defense spending.
If you're on schedule to do some annual rebalancing between the proportions of stock versus bond mutual funds you own, this is also the time to reflect on the quality of what you purchase -- not just the quantity. For starters, someone approaching retirement within the next 10 years might be wise to have a third of their money in bonds at this point. This is considered the statistical "sweet spot" that offers the most amount of downside protection while giving up the least amount of upside potential. Remember, we will definitely have higher inflation sooner or later that demands a continued investment in stocks for the time being.
However, for the bond side of the equation, consider investing some portion in high yield or emerging markets funds. Vanguard High Yield Corporate and T. Rowe Price Emerging Markets are reasonable candidates. For something more aggressive still, there is Artio Global High Income, which invests in an eclectic assortment of debt instruments around the world.
Funds like this involve substantial risk as bond funds go, but they are still bond funds buying essentially loans instead of equity in companies. Higher-interest earnings over long periods more than compensate in my experience. This, after all, was the genius of Michael Milken when he recognized the value of what others thought were just "junk." All three of these funds are currently yielding over 6 percent.
On the stock side, value-oriented mutual funds purchasing stocks that pay high dividends are, in fact, generating dividend returns of more than 3 percent. Incorporating some of these unorthodox funds into a portfolio can "move the needle" and add additional income for re-investment. Expect to lose perhaps a percent per year of capital value from the bond funds, cutting the 6 percent to a net 5 percent, but increasing capital values on the stock side, due to inflation alone over time, should more than compensate. The reward for the combination will be a larger stream of ongoing income with a reasonable protection of capital over the long term.