This year has seen stocks rise by a huge percentage and bonds were hurt by rising rates. People wonder what are the 2013 financial predictions for 401k investing. Bonds could go down more if rates rise when the Federal Reserve raises interest rates, which could happen next month through “tapering” of the bond purchase program. If stocks went up a lot this year does that mean they will go down, thus damaging their 401k? If they put their stock allocation into a 401k and diversify by putting their bond allocation in a taxable account would that be bad for tax planning purposes? Investors should seek independent financial advice about investing and tax planning.
The best way to make a 2013 financial prediction for 401k investing is to first realize that market timing is difficult and unreliable. Instead one should focus on strategies such as “market boycotting” where an investor simply refuses to buy an asset if it is overpriced, and better yet when it seems to be a good time to buy, one should insist on waiting to buy at a discount so as have a built in margin of safety. Based on metrics such as the Shiller PE10 which is now at 24 (normally it should be in the mid-teens) then stocks are overpriced, which implies they could go down roughly 38% to about 1050 for the SP. No one knows when a catalyst will provoke a panic that will make stock prices drop down to fair value.
Another strategy for 2013 for 401k planning is to remember that these are retirement accounts so they need to be invested more conservatively than a taxable account, which implies that perhaps bonds aren’t so bad after all as long as duration is short term.
It may be best to invest a 401k in “Stable Value funds” which are usually only available in a 401k, or a short term bond fund. Both pay a greater yield than if you stuffed cash in your mattress but not much more than that. But if stocks cost you a 45% capital loss then you will respect your “mattress investment”. There was a 45% stock market crash in 2001-2002 and again in 2008-2009. Some theories indicate there are supposed to be three crashes before a “cleansing phase” creates a new bull market, so be careful that you are protected during the third crash.
The stock market bulls main reason for saying stocks are OK is because the current year’s earnings PE ratio is reasonable, however, when one looks into the detail and sees that earnings (as a percent of sales) are actually abnormally high and may go down to normal levels then PE ratios are too high even on a short term basis (in addition to being too high on a 10 year PE basis). The other reason stock market bulls like stocks is because interest rates are lower than yields on some dividend paying stocks. Unfortunately that type of logic is based on negative thinking that because a person is offended by low bond yields they take out their anger by buying a different asset. This is not right, because one should pick investments based on building a positive case for an asset class from the ground up instead of simply getting mad at bonds because the yield is low. If the Fed raises interest rates then that would undermine the argument of stock market bulls. And an improving economy justifies future rate increases by the slow poke Fed which will certainly undermine stocks.
I have written an article “Fiscal Cliff to damage 401k’s”, even though the Fiscal Cliff was milder than thought it was still a risk that could reoccur.