401k Investing: Is the 401k a Relic of Past Investing Models? S&P 500 versus Certificate of Deposits.

Given the current investing climate, I think many people are questioning their investment strategy with the 401k.  Many have been led to believe that stock markets will always return 7 to 10 percent on an annualized basis.  Yet that is not the case.  In fact, as of March of this year if an investor had put away $10,000 a year in the S&P 500 in 1994 and the same amount in Certificate of Deposits the CDs would outperform the actual S&P 500:

Source: The Big Picture

So for a period of 15 years someone would have done better simply putting away their money in CDs.  However, the market since the March low has rallied substantially.  Yet the difference between CDs and stocks during this timeframe isn’t as significant as you may think.  Also, many people are realizing that even diversified stock portfolios stand to lose large amounts of money.

So what is one to do with their 401k?  Should you keep putting more money into your portfolio?  As of today, the current stock market rally seems to be based largely on overly optimistic valuations.  In fact, if we are to look at the PE ratio of stocks it is off the charts:

As of September 30^th the P/E ratio for the S&P 500 was 140.  So clearly the market is using future estimates as it should to determine that actual value of the market.  But even if we look at more conservative P/E ratios the market is still extremely overvalued.

So if you are planning on adding more to your 401k you may be buying at a historically high point even though it might seem like a bargain.  It may only appear to be a bargain given the massive drop since the summer of 2007.  Yet a drop does not signify value.

It is interesting to note that this last bubble pushed ratios higher than the Great Depression.  The problem with most basic stock analysis is that it leaves out eras like the Great Depression.  Many times, analyst will conveniently use 70 or 100 year analysis but don’t factor in deflation/inflation appropriately.  For example in the last year we have seen deflation registering in the CPI.  So I-Bonds are now paying 0 percent even if people had a fixed rate.  So if you can keep the same amount of money you had last year, you are in good shape.  The stock market if we look at valuation levels is overvalued because it is assuming a V shaped recovery.  This is largely misplaced.

It is important to invest and save money.  That is clear.  But just like the idea of buying real estate because it never goes down people need to be willing to examine a more diversified portfolio.  This doesn’t mean having low, mid, or large cap stocks.  This means having CDs, bonds, precious metals, real estate, and a mix of items at good prices.  This is never taught so it isn’t a surprise why so many people have seen their net worth get crushed.  Since the bubble burst in 2007, some $12 trillion in household wealth has disappeared.  Time to question the strategy and look more carefully at where you put your money.

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