Money: Sit Out or Spread Out?

Stocks, bonds, the dollar and real estate look pricey. Here's what to do

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Warren Buffett says it's difficult to find cheap stocks to buy; bond-market guru Bill Gross says the days of falling interest rates (and rising bond prices) are over. Real estate--the kind you live in as well as publicly traded trusts that invest in malls, offices and apartments--will stumble if, as expected, interest rates move higher. So what's an investor to do?

"When nothing looks good, buy everything," says Sam Stovall, chief investment strategist at Standard & Poor's, in a pitch for diversification. That's easy to say. But what does it really mean? If you're assessing your portfolio or reallocating a retirement account, you may still be asking yourself, Where do I put money now?

The simple answer is that sitting on the sidelines indefinitely is a bad plan--even though there are plenty of people who have been hoarding cash. Markets tend to rise and fall within a narrow band (what Wall Street experts call "a trading range"), sometimes for years at a time. Then they move suddenly--up more often than down. If you miss those unpredictable jumps, you often lose out on the biggest gains. The S&P 500, including dividends, rose an average annual 12% in the past 10 years. But if you were out of the market on just the 10 best days during that period, your gain would have been cut nearly in half, to 6.8%, reports fund company T. Rowe Price. "When you miss big moves it's really hard to make up that lost ground," says Ned Notzon, who runs the firm's Spectrum funds.

It's also a mistake to assume that you can't get ahead with stocks as they tread water. For one thing, dividends are on the rise; S&P 500 firms will pay out $200 billion this year, up 10%. And over the past five years, as stocks have fallen and then begun to recover, investors who put a steady $100 a month into the S&P 500 would have seen their total investment of $6,000 grow to about $6,800, although the market fell 11%, including dividends (see chart).

Even if the next five years wind up as choppy as the past five, stocks probably won't kill you--and could bring a tidy gain. Most pros see economic growth of 3% to 4% ahead, a healthy backdrop for profits, and also expect the dollar to fall. That's a good combination for the big U.S. multinationals that dominate the stock indexes. After five years of small stocks doing best, says T. Rowe's Notzon, the pendulum should swing back to large stocks that pay a dividend.

David Darst, chief investment strategist at Morgan Stanley's Individual Investor Group, argues that with the dollar's weakness, "you need something international to generate currency gains." Consider an unhedged international bond fund like Pimco Foreign Bond or T. Rowe Price International Bond. They pay a fixed income, which rises as the dollar falls and vice versa.

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