Friday, February 24, 2012

How to Make Money in a Sideways Market

The stock market always goes up in the long run...or does it? It is commonly accepted that the stock market generally trends upwards over time so taking a buy and hold strategy should be effective. However, that has not been the case since the year 2000, and hasn't always been the case throughout history either.

The stock market has tended to alternate between periods of dramatic advances of 500 to 1000% during secular bull markets, and long periods of volatile, range-bound movement. What is disconcerting is that these periods can be as long as 15 to 20 years.  So what can YOU do to ensure your retirement plan or investment portfolio doesn't participate in this performance vacation?

The first step is to identify what rate of return you require to meet your future funding needs.  You will need the services of a financial advisor to help you with this.  Pension funds use the 25 year government guaranteed bond yield as their discounting figure for this calculation, which today is about 2.64%.  Therein lies the problem, using this low return figure would require such a large amount of annual savings relative to your annual income that it would be impossible for anybody to attain.  This means that you must accept some risk in order to attain a return that would make the savings requirement affordable.  I use a 6% return which would imply an asset mixture of about 60% stocks and 40% fixed income.

Whether that asset mixture actually attains that return depends on when you invest and how you allocate those savings throughout the business cycle.  In a range-bound, or sideways market, income is critical - you want to get paid to wait.  For this reason, dividend paying stocks should be your vehicle on the stock side of the ledger.  On the bond side, since government bonds pay so little, corporate bonds should be used.  Investing in corporate bonds requires specialized knowledge and enough money to properly diversify.  For these reasons you should use professional money managers.

During your accumulation period you should add to either the stock side or the bond side depending on which of these asset classes are better priced.  You should not automatically add in equal proportions. 

The bottom line is you need income producing investments that are professionally managed and to be careful to add more to the asset class that is cheapest throughout the economic cycle.  Today, that means avoiding government bonds, and instead seeking out high-yield bonds and dividend stocks.