Best ways to invest in the current market

By Elliot Raphaelson
Posted on November 03, 2022

Investors in both the stock and the bond markets are understandably nervous. The Federal Reserve has indicated that, until inflation is under control, it will continue to increase interest rates.

As long as that happens, it is likely that both bond prices and stock prices will remain under pressure and may continue to fall in value. Most investors are not sure what action, if any, is best.

In late September, Burton Malkiel wrote a column in the Wall Street Journal with sound advice for investors both years away from retirement and currently in retirement.

Malkiel has a stellar reputation in the investment field. He wrote the excellent book, A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, which he regularly updates. A revised edition will be published in 2023.

Malkiel believes, as I do, that most investors in the stock market — on a long-term basis — should be investing in low-cost mutual funds and exchange-traded funds (ETFs) using dollar-cost averaging.

Early this year, he recommended that investors seriously consider investing in Series I inflation-protected savings bonds because of the safety of the investment and the high interest rate. This investment still has these features. [See “How to protect your portfolio this year,” in the July Beacon.]

In the Wall Street Journal, Malkiel pointed out that, even with the recent fall in stock market values, the cyclically adjusted price-earnings ratio, known as CAPE, is still pretty high historically. He indicated that, historically, with CAPE values at this level, 10-year returns have been well below average.

Common stocks best for long-term

However, he doesn’t believe that this is a time to give up on equities. He believes that long-term investors saving to build a retirement nest egg should be investing in a portfolio heavily weighted with common stocks.

He believes that common stocks representing the ownership of real assets have been an inflation hedge for more than a century, and he believes this will continue to be true.

Malkiel recommends diversified index mutual funds and ETFs with low costs. He points out that even during periods in which the returns on common stock investments are below average, when investors invest a specific dollar amount each month over an extended time frame (known as dollar-cost averaging), the overall results will be above the inflation rate.

In his article, he provides positive historical results during time frames in which common stock returns were below average. For example, in the period between the beginning of 1968 and the end of 1979, when the stock market was in a downturn with stagflation and a volatile stock market, those who invested in a low-cost S&P index fund received a return of 5.2% per year.

The bottom line is that even during periods of below-average common stock returns, those who invest steadily in a diversified low-cost index fund can still come out ahead.

What to sell to pay RMDs

Malkiel makes an important point for retirees who need to sell some of their investments.

He does not recommend dollar-cost averaging of equities in this situation. He believes that the appropriate approach is holding a diversified portfolio, including limited-duration fixed-income instruments, such as short-term bonds.

He recommends liquidating these fixed-income investments in order to meet Required Minimum Distributions (RMDs). He also believes that in order to provide inflation protection, one’s other investments should be tilted toward common stock holdings that pay high dividends.

I have been following this approach. In my portfolio, I have concentrated my bond portfolio to those of shorter duration. That’s because when interest rates increase, long-term bonds fall in value more steeply than shorter-term bond holdings.

I am required to take RMDs from my portfolio and, rather than sell equities, I generally take my withdrawals from shorter-term bond holdings.

In my stock portfolio, I have concentrated the majority of my investments in equities with a history of increasing dividends.

Elliot Raphaelson welcomes your questions and comments at raphelliot@gmail.com.