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Why now’s the time for investors to hold a little more cash

(Washington Post Illustration; iStock)
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Stock markets are trading at all-time highs. But instead of encouraging investors to pile in, financial advisers are giving more cautious guidance: Hold more cash.

Some advisers and market analysts say the new records recently seen in the equity market almost once or twice a week — the last one was Monday — serve as a reminder of how difficult it is to be an investor right now. People with money to invest are forced to choose between stocks trading at record-high prices and bonds paying rock-bottom yields, they say.

The predicament has advisers and analysts at some of the biggest firms on Wall Street, including Goldman Sachs, Prudential and Charles Schwab, recommending that investors use this time while stocks are reaching new records to add to their cash piles.

“There’s a worry in the market that they’re both overpriced,” Quincy Krosby, a market strategist at Prudential Financial, said about stock and bond markets. “That’s why you’re seeing more holdings in cash and gold.”

On the stocks side, questions linger over whether the market is simply breaking into new ground or setting up for more losses. After stock markets break a record once, it doesn’t take much to reach another new high. The Standard & Poor 500-stock index has closed at new highs at least 10 times since mid-July — once after a daily gain of 0.01 percent.

But stocks will have a hard time climbing substantially higher without stronger earnings growth, said Howard Silverblatt, a senior index analyst for S&P Dow Jones Indices.

Some metrics suggest that the gains in the stock market are outpacing the growth seen in the companies that make up the major stock indexes. For example, some analysts look at what’s known as the price-earnings ratio, which measures how the price of a stock compares to the earnings growth for that company. (The higher the ratio, the more expensive the stock.) The PE ratio for the Standard & Poor’s 500-stock index is now above 20, which is higher than the long-term average of 16.

“We’re paying too much,” said Silverblatt, adding that the higher ratios suggest investors are counting on stronger earnings that haven’t materialized yet. “Companies’ profits are expected to get better, but it’s very uneasy on the Street.”

On the bond side, yields are so low that investors looking to grow their cash in this safer pocket of the market will need to pay a steep price — and be extremely patient. With 10-year Treasury bonds paying about 1.6 percent, it would take 45 years for an investment in those bonds to double, according to an analysis by LPL Financial. In 2001, when the yield on 10-year Treasury bonds was closer to 5 percent, that investment would have doubled in 14 years.

With markets looking pricey, some advisers say it may be smart to sell stocks that have done particularly well and to hold more cash until better opportunities come up. Figuring out exactly how much cash to hold or how much stock to sell will depend on when the money will be needed.

People in retirement or who plan to retire within two years can sell stocks now to build up their cash cushions, said Antwone Harris, a senior financial consultant with Charles Schwab. Investors in this situation should sell enough stock until they have as much cash as they need to cover everyday expenses for one or two years, he said. “You don’t want to be in a position where you have to sell stocks to pay the bills during a down market,” Harris said.

Savers who are a bit further away from retirement, say three to five years, don’t need to have as much cash set aside just yet, he said. But when stocks are high as they are now, they can use it as an opportunity to build up at least part of the cash bucket they’ll need in retirement by selling some stock, Harris said.

For people investing for the long run, such as those at least 10 years away from retirement, it might make sense to simply rebalance portfolios if they find that the run up in stocks has left them holding more equities than planned, said Heather Evans, senior vice president and wealth management adviser for Merrill Lynch. Take someone who would normally invest 60 percent of his portfolio in stocks, 35 percent in bonds and 5 percent in cash, based on when he planned to retire. If stocks now make up 70 percent of his total portfolio, he could sell some stocks to bring it down to 60 percent target, and add to his cash and bond holdings, she said.

People with a pile of cash they want to invest now may feel paralyzed by the fear that there are no good options. If they pile all of the money into the stock market now, they might feel foolish if the market plummets in the next several weeks and months. But if they wait for stocks to fall before they invest, they could end up missing out on gains if stocks manage to keep rising, said Richard Dale Horn, senior vice president of wealth management for UBS Financial Services.

The answer, he says, is to invest the money a little bit at a time. That way the person is limiting losses if stocks plunge tomorrow but would still benefit from gains if the stock market keeps climbing. For instance, someone with $12,000 to invest over the next year can invest $1,000 a month. And if it turns out that stocks do fall — say the S&P 500 drops by 15 percent — that investor can increase how much he or she is contributing each month to take advantage and buy more stocks while they’re cheap. “Having some flexibility there certainly makes sense,” Horn said.

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