HOPE SPRINGS ETERNAL for mega-cap tech, meme stocks and cryptocurrencies. And the bond market is starting to party again, too. True, the financial markets have pulled back in the two trading days since Friday morning’s strong jobs report. Still, year-to-date performance has been startling. Investor’s Business Daily reported recently that just 10 stocks, including Apple, Amazon, Tesla, Alphabet (parent of Google), Nvidia, Microsoft and Meta (parent of Facebook), have accounted for half of the S&P 500’s 7% year-to-date rally. Bitcoin is up more than 38% since year-end 2022, and movie-theater meme stock AMC has jumped 67%. Meanwhile, though the Federal Reserve continues to raise short-term interest rates, iShares Core U.S. Aggregate Bond ETF (symbol: AGG) and iShares iBoxx High Yield Corporate Bond ETF (HYG) are up more than 7% since late October. So, is the bear market behind us? Was that it? Is big tech back? Color me skeptical, especially on that last question. The four biggest technology stocks in the S&P 500 as of December still represented a greater percentage of the index than the four largest did at the peak of the dot-com bubble, notes Goldman Sachs. Valuations in the rest of the stock market may look good, but can the same be said for mega-cap tech? The market seems to be sending mixed signals. Intermediate and longer-term Treasurys are trading as though the Fed will soon start cutting rates, perhaps as the result of a recession. Yet stocks and high-yield bonds are acting as though corporate profits and the ability to repay debt will weather any economic slowdown. The spread—or extra yield—of high-yield bonds over Treasurys is just under four percentage points, below the 25-year average of 5.4. During past recessions, the high-yield spread has reached eight percentage points and sometimes much higher, including 11 points in 2002 and 20 points in 2008. If the yield spread were to widen to eight points, that would mean steep losses for high-yield “junk” bonds. The rally in bonds and growth stocks caught me a little flat-footed. My lean toward value stocks and short-term Treasurys—which benefited me so much last year—is causing me to miss some of this year’s headline-grabbing action. I had expected the cycle of value outperformance to last at least a few years, as happened after 2000, when the dot-com bubble burst. The good thing is, I didn’t bet the farm on that. I’m fully invested based on my target asset allocation. Index funds and balanced funds make up most of my portfolio. That means I’m capturing much of 2023’s unexpected upside—but not all of it.

WHAT’S THE BIGGEST threat to your retirement? For young adults, we know a key pitfall is failing to invest in stocks because they’re so afraid of the market’s short-term ups and downs, thus unwittingly risking impoverishment later in life. But for those of us nearing retirement, the market’s ups and downs can start to matter more than stocks’ long-term inflation-beating performance. An ill-timed market crash or a run of bad annual returns could ruin our retirement plans. What to do? That depends on a host of factors, including your nest egg’s size, your ability to work longer if necessary, and the potential income and satisfaction you might derive from part-time work once you leave fulltime employment. There’s a point at which you should strive for growth and a point at which you should focus on conserving wealth—but those points will be different for each of us. My late mother had a decent-size portfolio. But during the final 15 months of her life, which spanned 2020-21, she required round-the-clock home health aides at a cost of $220,000 a year. We had no idea how long those expenses would go on. Mom, to her credit, had never before touched her portfolio. But during that 15-month stretch, I was forced to sell some investments at inopportune times on her behalf. Her end-of-life health care costs were a wakeup call for me. If you’re far short of a multi-million-dollar portfolio, like I am, you may have little choice but to continue living on a tight budget for the remainder of your working years, while also investing mostly in stocks. I know some say I should start traveling more now, while I have my health and can still get around. But I’m not earmarking a lot of money for overseas adventures. Maybe I’ll do one trip every three years or so. That’s despite the fact that, with my hip in need of possible replacement, I can imagine a future where strolling through the old town of a foreign capital will be painful. But at the same time, I also see the news of people dying who weren’t much older than I am now. My caution today is the price I pay for ruining my finances in my 40s, when I devastated my portfolio by making risky investments using margin debt. I don’t get the three-week Europe jaunt, at least not yet. I could probably spend more, but it isn’t my goal to die broke. If possible, I’d like to leave an inheritance to my two children. In the meantime, I still need growth. I’m 62, and I hope and plan to work for another five years or so. I may be able to work even longer, if that proves necessary. My profession—writing and editing—lends itself to part-time work in retirement, even with my arthritic joints. There are ways to get more conservative while investing for growth. I have about 72% of my portfolio in stocks and stock funds, though I’m planning to reduce that by one or two percentage points a year. That would still leave me with more than 60% in stocks at my planned retirement age, which is perhaps somewhat aggressive. I wrote earlier about how I’m increasingly limiting risk in my bond-market money. Within my stock holdings, I’m also trying to reduce risk, but that’s easier said than done. I’m diversified across U.S. and foreign stocks. I also have a little extra in energy and defense stocks as a hedge against events that could drive the broad market lower. I’m intentionally minimizing exposure to China, as I’ve written here and here. Partly as a result, I’m light on emerging markets. In addition, I lean toward a value investing style, especially small-cap value. I consider limiting exposure to high-priced mega-cap tech stocks—which today dominate the S&P 500-stock index—as a way to reduce risk. Indeed, true market-capitalization-weighted index funds only account for half of my portfolio. Unfortunately, other investors seem to be seeing more risk in small-cap value right now than in technology, partly due to fears about a recession and the banking sector. But I’m sticking to my value tilt. Still, there are risks in waiting for value to return to favor and deliver a multi-year period of outperformance. Investment styles can lag badly for many years, as value has, and my plan is to gradually move closer to complete market-cap indexing as I get older. Moreover, value stocks aren’t immune to market collapses. Sometimes, they don’t hold up much better than growth stocks, if at all. My approach paid off in 2020-22, a big improvement over my previous track record. My losses were well-contained last year. But with growth taking off again this year and value far behind, I’m fearful I’ll miss the boat again by not fully indexing. Maybe I’m living my own variation of Daniel Kahneman’s Prospect Theory, which states that we hate losses twice as much as we love gains. I’d rather lag the market on the upside than be fully exposed to today’s glamour stocks and the danger that there’s a bubble about to burst. Telling myself “I told you so” would be unbearable. William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart and check out his earlier articles. [xyz-ihs snippet="Donate"]

YOU'VE HEARD OF asset allocation. But how good are you at asset location? On that one, I’d have to give myself a failing grade, but I hope to pass the test someday. I’ve realized I could save myself hundreds of dollars a year in taxes by relocating much of my safe money to tax-advantaged accounts, while being more aggressive with stocks in my taxable account. Those moves would leave me with the same overall stock allocation, so my risk profile wouldn’t be much different. In some ways, I’m a cautious investor, especially when it comes to my emergency fund. I’ve got a hefty allocation to stocks—currently about 70%—but I’ve also got a year and a half of living expenses in individual Treasurys, a certificate of deposit (CD) and money market funds. I figure my fixed expenses are $5,000 a month, so that’s $90,000 in safe money sitting in my taxable account. With current short-term interest rates over 5%, my conservative stance is raking in some good bucks, but it’s too much safety and too much taxable income. One reason it’s so much: I’m trying to save up five years’ worth of portfolio withdrawals in bonds and cash by the time I retire. At that point, with Social Security benefits of more than $2,000 a month, I reckon I’ll need just $3,000 monthly from savings to maintain something like my current lifestyle. The cash cushion I’m accumulating will protect me from a prolonged bear market. Intuitively, you might think emergency funds don’t belong in retirement accounts, which experts say should be invested for long-term growth. After all, who wants to raid an IRA to pay bills before they retire? But the truth is, not all good investment advice is good for all people all the time. I’m over age 59½, so I can withdraw from my retirement accounts without penalty. Moreover, the only way I’ll need to draw heavily on my emergency fund is if I lose my job or am unable to work for an extended period. In that case, I’d be in a lower tax bracket, so pulling funds from an IRA wouldn’t have onerous tax consequences. I got the novel idea of keeping my emergency money in my IRA from HumbleDollar’s editor. He advocates keeping tax-inefficient, interest-generating investments in tax-sheltered accounts, while going heavier on stocks in taxable accounts. My first reaction to the suggestion: What if an emergency occurs when stocks are down? I could be selling in a bear market just to buy groceries and pay rent. But here’s the trick: Yes, in my taxable account, I might find myself selling when stocks are down. But I can swap an equivalent amount from conservative investments to stocks in my tax-advantaged accounts, so my overall asset allocation stays the same and I don’t miss any recovery in the market. Some suggest going as low as three months of living expenses in a taxable account. I’m more comfortable with at least six months’ worth—big, unexpected expenses can still crop up even if I don’t lose my job. But that still gives me a lot of room to increase my stock allocation in my taxable account, while correspondingly boosting my cash and bond holdings in my IRAs and 401(k). How much is at stake? Suppose I reduce my emergency savings in my taxable account to six months’ living expenses, or $30,000, from the current $90,000. I could rearrange my asset location and thereby shed $60,000 of interest-bearing cash and bonds in my taxable account. With 5% currently available on short-term Treasurys, CDs and money funds, I’m paying a 22% income tax rate on the $3,000 annual interest from that $60,000, or $660 per year. Yet, if I took that $60,000 and invested it in a broad U.S. stock market index fund in my taxable account, I’d pay just a 15% capital gains tax rate on the 1.4% dividend yield. That’s just $126 in taxes per year, for an annual savings of $534. Of course, eventually I or my heirs will owe taxes on withdrawals from my traditional IRA. But that could be at a lower tax rate and, in any case, it’s potentially many, many years down the road. William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on X @BillEhart and check out his earlier articles. [xyz-ihs snippet="Donate"]

I’VE BEEN WRONG many times, as I’ve noted in earlier articles. But the past few months have made me—and maybe you—look like an investment genius. I’ve had some nice “wins” since March 13, when I started buying the stock market dip. Does that make me brilliant? Of course not. Was I “right”? That depends on how I made my decisions. A quick profit doesn’t necessarily mean I made the right call. Too often, when we analyze our investment moves, we judge them by whether we made money—and usually our focus is short term. We wanna know if we were “right” right away. But that’s the wrong way to look at it. As Wall Street Journal investment columnist Jason Zweig reminded readers recently, he touched on this topic in 1999. He was writing then about assessing whether certain investment strategies “worked.” “More than ever, people think the test of an investment’s validity is whether it ‘worked'.… But investing successfully over the course of a lifetime has nothing to do with being right in the short term.… Imagine that two places are 130 miles apart. If I observe the 65-mph speed limit, I’ll drive this distance in two hours. But if I go 130 mph, I can get there in just one hour. If I try this and survive, am I ‘right’?” Exactly right. That is to say, no, he would be wrong. Evaluating an investment over a long period gets closer to answering the right vs. wrong question. But even then, the result doesn’t wholly validate or invalidate the decision. Eight years ago, was I “wrong” to buy Pepsi and Coca-Cola instead of Apple for my son and daughter, respectively, when I wanted to teach them about investing? It’s hard to say I was “right.” Since the purchases, Apple has returned 375%, versus 153% for my son’s Pepsi and 66% for my daughter’s Coke. Vanguard Group's S&P 500 index fund returned 177%. But how was I “wrong”? The Pepsi and Coke investments served their primary purpose: to teach the kids the superior return potential of stocks versus a savings account—and to show them how money can work for them, rather than the other way around. At least Pepsi and Coke have been, ahem, less volatile than Apple. I had told myself explicitly that I wasn’t trying to beat the market, just trying to buy a couple of companies that two teenagers could understand. As indexers know, there was no way for anyone to predict which of the three stocks would do better. Apple at that point was up about 1,700% from its March 2000 peak, versus about 15% for the Vanguard S&P 500 fund. (Incidentally, when I bought the shares in 2012, the vast majority of analysts recommended Coke over Pepsi.) The point is, my decision making was sound enough. It was rational and defensible based on my objectives, on what I knew and—in fact—on what was knowable. Back to this year’s market decline: I bought the dip fairly aggressively in March, in accordance with my plan. Even though I got spooked in April and deviated from my plan by trimming stocks during the rally—score those sells "partially wrong"—the moves I made have netted out fairly well so far. I bought a small-cap value fund on March 13. In my Mom’s portfolio, I worked with her advisor to sell a muni fund and buy a total world stock fund. Both have performed spectacularly since then. Was I “right”? Again, that depends. The quick gains don’t make me right. I did know that small-cap value often outperforms coming out of a market bottom. During the dot-com bust 20 years ago, small-cap value started rising shortly after the insanely valued large-cap tech stocks began to crater. But when I bought this year, I had absolutely no way of knowing whether we’d reached bottom or were even close to it. So what was right about those two decisions? The same thing that would be right if both funds were “losers” right now. They were rational decisions made in accordance with a pre-existing plan to buy dips of a certain magnitude and not to let my allocation to stocks get too low. They also made sense as diversifying moves. Mom’s portfolio—literally one for “widows and orphans”—was heavily skewed toward muni bonds and domestic value stocks. The bottom line: Don’t judge yourself by how much money you make. Instead, judge whether you tend to make well-reasoned decisions appropriate for your situation and based on known facts, rather than on hunches, hopes or fears—or the fact that your cousin is making a fortune in Apple and can’t stop boasting about it. William Ehart is a journalist in the Washington, D.C., area. Bill's previous articles include Red Flags, Averting My Gaze and In and Out. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart. [xyz-ihs snippet="Donate"]

WELCOME TO OUR inaugural monthly personal-finance update. I was all ready to write about January’s robust stock market—and then the GameStop saga garnered national headlines, with short-selling hedge funds losing billions, everyday investors crowing and politicians piping up. Some bashed Wall Street for allegedly thwarting retail traders, while others worried about the financial system’s stability. Amid the tumult, the S&P 500 fell into the red for the year-to-date, despite blockbuster earnings reports from two of the market’s longtime leaders, Microsoft and Apple. Renewed concerns about the economic impact of COVID-19 also weighed on the market. Still, small-company stocks’ gains weren’t entirely erased—further proof for the so-called January Effect, the tendency for small stocks to outperform during the year’s first month. Vanguard Small-Cap ETF (symbol: VB) held on for a 2% gain, despite losing nearly 5% in the month’s final week. But the S&P 500 closed the month down 1%. Does that put the kibosh on 2021? The January Barometer, sometimes confused with the January Effect, posits that as goes January, so goes the year. But such Wall Street lore is more proverbial than tradeable. Should auld acquaintance be forgot? Large-cap U.S. growth stocks, seemingly so unbeatable for so long, reached peak outperformance in early September. As a group, the stocks continued to lag behind small caps in January, with Vanguard Growth ETF (VUG) down 1%. Tesla (TSLA), up 12% last month, was the biggest exception, though Microsoft and Google’s parent Alphabet gained 4% and nearly 5%, respectively. Vanguard Small-Cap Growth ETF (VBK) and Vanguard Small-Cap Value ETF (VBR) both gained some 2%, as their investment styles sparkled, as they have for the past three months, with advances of 26% and 28%, respectively. Truth be told, the Vanguard Extended Market ETF (VFX), which tracks small- and mid-cap stocks, bested both of them over one month (+3%) and three months (+30%). The latter result was powered by former index component Tesla, which is up nearly 600% over the past year and is now the nation’s fifth-largest company by stock market capitalization. The electric car maker was added to the S&P 500 index on Dec. 21 and is no longer held in Vanguard Extended Market. Asia ascendant. Some of the best action around the globe in January was along the Pacific Rim. BlackRock’s iShares MSCI China ETF (MCHI) gained 8% and iShares MSCI Taiwan ETF (EWT) was up 4%, despite significant declines in the final week. That drove broader emerging markets funds higher, with Vanguard FTSE Emerging Markets ETF (VWO) climbing 3%. Based on reported data, China was the only major economy to grow in 2020, apparently helped by aggressive containment of COVID-19. Foreign stocks as a whole slightly outperformed the S&P 500 in January, as reflected in a 0.4% gain for Vanguard FTSE All-World ex-U.S. ETF (VEU). But foreign small-caps didn’t get the memo that it was time to shine, with Vanguard FTSE All-World ex-U.S. Small-Cap ETF (VSS) down 0.6% last month. Steeper curve. In recent memory, the yield curve—the relationship of longer-term Treasury bond yields to those of shorter-term Treasury yields—has been somewhat flat. No more. The Federal Reserve has pushed short-term rates to the floor, while optimism about a recovery has pulled long-term yields higher. Whereas the short and intermediate areas of the curve used to offer an attractive mix of income and safety, yields there are now low both in absolute terms and relative to longer-term yields. The yield advantage of 10-year Treasurys over two-year Treasurys recently hit its highest level since mid-2017. But before you don your climbing gear, realize that even the 30-year yield, which ended January at 1.87%, is far lower than it was two years ago, when the long bond yielded 2.99%. That’s a lot of room for rates to rise and hence for investors to lose a ton of money in a long-term Treasury fund. For instance, the Vanguard Long-Term Treasury ETF (VGLT) has an average duration—a measure of interest-rate sensitivity—of 18.6 years. That suggests that if long-term rates were to rise one percentage point—say, back to 2019 levels—the fund’s price would fall more than 18%. (On the other hand, it would gain that much if interest rates fell one percentage point.) The Vanguard fund slumped 3.5% in January, but still has a gain of nearly 6% for the past 12 months. Perhaps online savings accounts, yielding in the half-percentage-point range, are better places today to park your safe money. William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart and check out his earlier articles. [xyz-ihs snippet="Donate"]

CAN YOU EVER HAVE enough? Yes, I’m talking about money. But I’m not some gazillionaire burning up billions on a rocket to space. I’m talking about emergency savings for ordinary people. A cash stash. Rainy-day funds. Mattress money. I thought I had enough a few months ago, but then life happened. Dental work. A blown clutch. More support for my son, who has a great job offer but won’t start work until later this year. Boom, a big chunk of my savings was gone and, for now, it’s not growing back. Experts say you should keep between three and six months of living expenses in a safe place, free from the vagaries of the stock and bond markets. You can stash the cash in a savings account at a local bank (yielding little more than your mattress), certificates of deposit, saving bonds from the U.S. Treasury or in an online savings account that won’t yield much (but still many times more than your brick-and-mortar bank will pay you). I can’t bring myself to tie up money in CDs and savings bonds, partly because I may need the money suddenly. Instead, I’m partial to the liquidity of my FDIC-insured online savings account. It’s with Ally Bank, yielding about 0.50%, but there are other providers. You can compare their rates here. One thing I like about online savings accounts is that I can put my money in buckets—segregated pools that I can designate for certain purposes. I have one for my daughter’s wedding. It isn’t enough to cover a decent reception—yet. But that’s okay, because she’s not engaged and might not be for years. I don’t count that money as part of my emergency fund because I’m determined never to tap it except for her big occasion. But I haven’t been able to add to it lately. [xyz-ihs snippet="Mobile-Subscribe"]  I have another bucket dedicated to what I hope can be a hefty down payment on my next car. I do count this money as part of my emergency savings. But when I spend from this bucket, my rainy-day fund will be smaller and in need of even more rebuilding. My plan is to make a large down payment on my next car, thereby reducing my monthly car payments. I’m hesitant, as an amateur, to say the experts are wrong about how much you need for emergencies. They typically suggest having three-to-six months’ worth of your fixed expenses saved up. But they’re wrong. Three months’ worth of expenses is absolutely nowhere near enough. After I got laid off in 2009, it took me nine months to find a good job. Six months of savings is a better rule of thumb. Except that when unexpected expenses do occur, you might be right back to having just three months’ worth of savings left. What if surprise expenses creep up on you—and shortly after that you lose your job? That kind of scenario may be unlikely, but it’s exactly what we should be prepared for. Nine months of expenses is my new savings target. I am only about halfway there. I had six months’ worth back in May, before the clutch, the dental work and the additional financial needs of my live-at-home college graduate. I just turned 60, so this would be a bad time to lose my job. On top of that, when my son does begin office work, he’ll need a car. Car prices have lately gone pedal to the metal. I may give him my car, a 2014 Volkswagen Jetta, or sell it to him for a couple of thousand dollars. Either way, I’ll need another car for myself before long. I’ll probably have to tap that car savings bucket, leaving me with even less for an emergency. At some point, I’d like to travel again. If my emergency funds were healthy, I’d be able to consider a nice trip. But a vacation involving airline tickets and hotel stays is out of the question for now. A first-world problem? For sure. How can I complain when the stock funds in my IRA are up so much? But don’t forget, the market could turn on a dime and my account could lose value. That’s another good reason to stockpile cash. Can I ever have enough? William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart and check out his earlier articles. [xyz-ihs snippet="Donate"]