Do you start quivering every time you hear the words "record high" and "stock market" in the same breath? When you peer into your Closet of Anxieties, do you see Charles Schwab? Do you have frequent nightmares about bears?
If you can answer "yes" to any of these questions, face it: You're a ragin' craven when it comes to the stock market. Market experts would tell you that your anxiety is good, and that as long as you and your fellow investors are properly terrified, the stock market will probably continue rising.
But you don't care. You're almost as afraid of the stock market as you are of living in a shed made of hammered-out soup cans in retirement. You need a stock investment that won't make you even more of a coward than you normally are. Fortunately, we have a few suggestions.
The Standard and Poor's 500 stock index hit its 41st record high Thursday, which is actually less scary than it sounds: The stock market is supposed to hit record highs in a bull market. Some day, of course, the market's record high will be followed by a period of falling prices, which is what most people fear.
If you have a comfortably long investment horizon — 10 years or more — then you should find other things to worry about, like whether you should have chosen those pants this morning. Over the long term, stocks tend to return more than bank CDs or government bonds.
And for many people, this is a TINA market — meaning There Is No Alternative. Money market funds yield nearly zero; bond yields are miserably low; and commodities are pumping mud. Your best alternative, it seems, is stocks.
But stocks are stretched, at least if you look at prices relative to earnings. According to Ned Davis Research, a respected Wall Street analytics firm, the median stock in the S&P 500 trades for 20 times earnings. That's high.
What's an investor to do? One alternative is to look for funds that seek bargains — and let cash build up when they can't find any. Cash can build up because investors shower them with money when the market is rising, or because their holdings reach their price targets, they sell them, and can't find suitably cheap stocks.
Consider Weitz Value Investor (ticker: WVALX), which has been overseen by veteran investor Wallace Weitz for more than 30 years. The fund has beaten 81% of its peers the past five years and currently has about 18% of its assets in cash.
A value investor like Weitz heeds the teachings of Warren Buffett — who, like Weitz, also calls Omaha home. (Buffett's Berkshire Hathaway is the third-largest holding in Weitz Value). Value investors look for stocks that are cheap, relative to earnings. Weitz spent about five percentage points of his funds' cash during the brief mini-correction in October, he says.
Buying cheap stocks has two benefits. First, they tend to be takeover targets because, well, they're cheap. Buyers nearly always overpay in takeovers. (Ironically, the fund's top holding is Valeant Pharmaceuticals, which has soared 13.1% this year during its attempt to buy Alleran, the maker of Botox.)
Second, value stocks tend to have above-average dividend yields. A dividend yield is the stock's dividend payout per share, divided by price. As prices fall, yields rise, all other things being equal). Texas Instruments, one of the fund's holdings, yields 2.4%, for example, vs. about 2% for the S&P 500.
Two other top-notch value funds that let cash run up:
•Longleaf Partners (LLPFX). Managers Staley Cates and Mason Hawkins have no problem letting cash run up in a bull market — currently, about 14% is in cash. It, too, has a healthy stake in Berkshire Hathaway, but it also likes some stocks that have been pounded lately, such as Chesapeake Energy and McDonald's.
•Primecap Odyssey Stock (POSKX). The fund has about 10% of its assets in cash but also boasts an exceptional long-term record and an appealingly low expense ratio.
The drawbacks? Funds that let cash run up will look like nitwits in a rip-snorting bull market. Weitz Value is up 6.4% this year, trailing the S&P 500 by nearly 11 percentage points. Longleaf Partners, which soared 32% in 2013, is up just 4.5% this year. Primecap, probably the best choice for your money, is up 11.5%.
And sometimes, cheap stocks are cheap for good reason. Bank stocks helped drag Weitz and Longleaf down in the last bear market. "What you want is for your stocks to be down for the wrong reasons," Weitz says. "You don't want your stocks to be down for the right reasons."
If you're an index investor, you have no real similar funds that allow cash to build up in frothy markets. If you are putting money away regularly, say in a 401(k) plan, you can simply direct new money to go to the cash option in your plan. Over time, your cash will build up, theoretically softening any impact from a bear market and leaving you with a reservoir of cash. But you'll have to make those decisions yourself.
Over the long term, a value approach has beaten most other methods of investing. And, while you'll still have plenty of moments of terror with a value fund, one that builds up cash might be the perfect way for a chicken to feather his nest.
