Anyone who's followed a disciplined fitness program knows the frustration of hitting that plateau—no matter how hard you pump iron, you get nowhere. Well, welcome to the stock market in 2016.
In the first six years following the financial crisis, the market had one of its best runs in history. Stocks tripled between March 2009 and last summer. You started with $10,000, you ended with $30,000. Since then? Zip. In fact, as of this writing, the market is down about 1% off its May 2015 high.
The U.S. stock market has had its ups and downs over the years, but it’s been mostly up, and it too has gotten far more expensive over the decades. In 1980, a common measure of stock valuations—stock price divided by earnings—stood at 7, well below historical averages. At the beginning of this year, it was 22, well-above average.
Mathematically, it simply can’t go much higher, which is why many pros believe the next 35 years are unlikely to be as generous to investors as the last 35. As a result, big financial firms are cutting back on spending, bracing themselves for lean times. Bill Gross, who until recently ran the world’s largest mutual fund, wrote that “a repeat performance [of historic returns] is not only unlikely, it is also impossible unless you’re a friend of Elon Musk’s and you...blast off for Mars. Planet Earth does not offer such opportunities.”
So, yes, for Wall Street investors, this means heartburn. For young guys like you, however, this means your 401(k) could suffer. But that’s only if you let it.
The good news is you can pump up your investments and bust through a market plateau in your 401(k) with the right investment strategy. Here’s what to do.
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Follow the simplest strategy in the book
Yes, you should buy what’s cheap. And to figure out what’s cheap, I checked in with Research Affiliates (RAFI), a pioneering group of financial eggheads who mix academic research with real-world money management. They publish a sobering chart showing what they expect different investments to return over the next 10 years. Their approach is as simple as it is brilliant: They base their predictions on current prices. Expensive stuff offers little in the way of future returns, while cheap stuff will reward investors.
So, for example, U.S. stocks are priced to return a pathetic 1.2%. Invest $10,000 and in 2026 you’d have $11,245 (adjusted for inflation). Bonds will give you 0.6%, turning that 10 grand into $10,588. Only slightly better than stuffing your cash in a mattress. Sure, picking the right stocks could get you a much better return, but even most pros can’t beat the market.
What’s cheap and ready to go much higher? One investment leaves the rest far behind: emerging market stocks. Think Brazil, Poland, Indonesia, Russia. Sound scary? Of course it does. If investors weren’t scared of putting their money there, the stocks wouldn’t be cheap. As Warren Buffett says, “Buy fear, sell greed.”
The rewards for buying fear will be huge. Emerging markets as a whole are priced to climb 8% a year, after inflation, according to their calculations. In fact Russian stocks are so cheap that RAFI expects 14.4% returns per year over the next 10 years. Poland and Brazil are priced to deliver north of 10% per year. I recommend splitting your money into two funds to diversify your holdings.
First: the Vanguard FTSE Emerging Markets Index exchange-traded fund, which (VWO) holds about 4,000 stocks from emerging markets all over the world. Its top two holdings are Tencent, the Chinese Internet powerhouse, and Taiwan Semiconductor. As an index fund, it doesn’t try to predict which stocks or countries will do well, it just owns them all. And thanks to its dirt-cheap expense ratio (0.15% of your investment each year), you keep more of the returns.
Second: Harding Loevner Emerging Markets (HLEMX). Over the past five years it’s down 15% (half the loss of the index), and it’s among the top picks of Morningstar, a Chicago research shop that rates mutual funds. That performance doesn’t come cheap: the fund charges 1.45%, a hair above average, and nearly 10 times the cost of the Vanguard fund.
Because an index fund simply buys and holds a broad range of stocks, an actively managed fund attempts to do better by buying stocks it thinks will do better and avoiding the duds.
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One hitch in this plan, though
The odds that your company’s 401(k) offers these exact funds is slim. Here’s how to solve that problem: If there’s an emerging markets fund in your plan, check its long-term performance and expense ratios against the two funds above. If it holds its own, invest in it. If not, here’s your play:
Make sure you invest the minimum needed to get the full company match in your retirement plan. But then, for your emerging markets stake, open an IRA with a company such as Fidelity or Schwab. If you earn less than $133,000 ($194,000 for couples filing jointly), make it a Roth IRA; that way you won’t owe taxes on the gains when you retire.
Uh, how much?
Glad you asked. Don’t bet your entire retirement stash on this thesis. Start with 10% of your savings, and if emerging markets keep falling, gradually raise that to 20%. I wouldn’t go any higher than that. And remember: Before they start climbing, emerging market stocks could fall further. U.S. stocks, meanwhile, could go higher. It’s impossible to predict short-term movements.
You, however, can afford to buy low and wait for the turnaround. You’ve got at least 35 years until retirement. Make good use of them.