Investing Becomes An All-or-nothing Game

Recent highs in the stock market have created a unique dilemma for investors -- or at least one that hasn't been seen in the last 50 years.

At previous market peaks, investors seeking a haven from high stock prices had the alternative of earning at least a respectable return in less risky vehicles. Savings accounts and other deposits offered solid and sometimes even attractive returns. But that is certainly not the case as the market explores new highs this time around.

The low-yield environment has made investing more of an all-or-nothing game, so investors had better make sure they understand its rules.

Bank rates at historical lows

A look at interest rates at prior market peaks shows why backing away from rising market risk would be a tougher decision today than in the past. The dates below correspond with previous peaks in the S&P 500 over the past 50 years. The rates shown are short-term certificate of deposit (CD) rates from the Federal Reserve, though you can assume that savings accounts and money market accounts would have been at similar levels.

January, 1966: 4.81 percent
November, 1968: 5.93 percent
December, 1972: 5.22 percent
December, 1976: 4.62 percent
November, 1980: 15.39 percent
August, 1987: 6.63 percent
January, 1994: 5.81 percent
March, 2000: 6.01 percent
October, 2007: 4.95 percent

Today, those same yields would be around 0.18 percent. Only time will tell whether recent stock market highs will turn out to be a peak, or simply a step on the way further up. However, as prices rise and market risk increases, investors don't have the option of earning a decent income if they choose to sit out the rest of the cycle. That's why investing has become an all-or-nothing game.

Rules of the all-or-nothing game

Here are some rules for investors in the all-or-nothing game created by low yields and high stock prices:
  1. Transition gradually in and out of stocks. Large market-timing moves in and out of stocks are never a good idea, but the contrast is even sharper now that there is nothing to be earned by waiting on the sideline. This calls for a more gradual transition out of stocks if you believe prices are getting too high.
  2. Know what you own. A pricey market is a bad time to own stocks generically. Know the fundamentals and valuations of the specific companies in your portfolio.
  3. Determine your risk parameters. Know what you can't afford to lose, and keep a corresponding portion of your portfolio in guaranteed vehicles, even if there is little return there.
  4. Be prepared to accept more volatility. Stocks are the only game in town right now if you want to earn a return, so that means accepting more ups and downs.

Higher interest rates would make this game a little easier, but the irony now is that it would be difficult for the stock market rally to survive a rise in rates. So, investors may not like this game, but it seems they have no choice but to play it.