The Smart Investment Decision Almost No One Makes

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Many investors feel constant pressure always to be doing something with their money. Yet under certain circumstances, your best move is to do nothing at all -- except prepare yourself for better opportunities in the future when they arise. The smartest way to do that is to divert some of your regular investment capital into a cash stash you can tap when the floodgates open and a host of new investment ideas look especially attractive.

Dealing with tough markets
Over time, investors inevitably find that market opportunities run in cycles. Sometimes, there are so many attractive investments out there that you have no hope of saving up enough capital to invest in all of them. Yet at other times, opportunities seem to dry up and there's very little that looks attractive.

It's not entirely clear which phase we're in right now, but lately, some investors have felt more like the pickings are getting scarce. Consider some particular challenges investors face right now:

  • The stock market has seen valuations start to rise as major indexes remain near all-time highs. On a trailing basis, the S&P 500 (SNPINDEX: ^GSPC  ) now fetches almost 18 times earnings.
  • Among individual stocks, those seeking defensively oriented names increasingly have to pay up for the privilege of downside protection. For instance, Coca-Cola (NYSE: KO  ) now trades for 20 times earnings despite the growth challenges it has faced lately. As continuing pressure comes from anti-obesity advocates and sluggish emerging market economies, Coke won't necessarily see earnings grow to justify its valuation. Similar factors apply to Kellogg (NYSE: K  ) , with an earnings multiple of 23 reflecting the premium that many low-volatility food stocks have enjoyed ever since Warren Buffett's deal to buy Heinz. The acquisition of Pringles last year has boosted Kellogg's growth prospects, but investors nevertheless should pay attention to valuation concerns.
  • In the bond market, yields have finally started to look somewhat more attractive, with the 10-year Treasury having nearly doubled in yield to approach 3%. Yet many expect further yield increases in the future, making current investment a risky proposition given the potential for substantial capital losses if rates continue to rise. Already, long-term bond investments iShares Barclays 20+ Year Treasury (NASDAQ: TLT  ) and iShares Barclays TIPS Bond (NYSEMKT: TIP  ) have suffered double-digit percentage losses in just the past several months, and they're vulnerable to further losses in a rising-rate environment.

In light of these conditions, some investors are getting frustrated. The prospect of holding onto cash that pays almost nothing in interest isn't appealing. But buying in at a potential market top doesn't seem smart, either.

Splitting the difference
One smart way to adapt to tough conditions without making too big an adjustment to your investing strategy is to divert a portion of your regular investment to a cash account. If you make automatic contributions toward your investments, don't give up on them entirely but reduce them somewhat in favor of stashing extra cash aside. That way, if a market correction comes that makes certain investments look more desirable, you'll be ready to pounce with a larger amount of money to invest.

The reason to do this with only some of your money is to avoid the downsides of market timing. Moving all your investable funds to cash runs the risk of missing out on continued gains in the stock market. Continuing to invest a portion of your savings lets you hedge your bets.

Be smart
Investing in a market where stocks are at or near new highs is always challenging. Choosing not to invest at all in those circumstances, however, isn't typically the right move. Instead, planning for multiple contingencies by setting aside a portion of your investable cash gives you maximum flexibility to handle whatever the future brings.

Unfortunately, millions of Americans have done nothing to invest their savings, missing out on huge gains and putting their financial futures in jeopardy. For them, we've written our brand-new special report, "Your Essential Guide to Start Investing Today," to show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.

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Comments from our Foolish Readers

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  • Report this Comment On September 10, 2013, at 7:25 PM, mclaugph wrote:

    Re: "Splitting the difference"

    Are there recommendations for how much (e.g., 10%) you should keep as cash? That would be a helpful follow-up article, and might be one reason "almost no one" does this.

  • Report this Comment On September 11, 2013, at 8:23 PM, Libor8erBlake700 wrote:

    0) I worked all through the winter

    The weather brass and bitter

    I put away a tenner

    Each week to make her better

    And when the time was ready

    We had to sell the telly

    (Up the Junktion by Squeeze (1978) based on Nell Dunn's novel (1963))

    1) How much to keep in kash, is not only trial-&-error desizion but it's personal too, as each person's need's different.

    2) There's always a dozen dezirible bonds or shares to invest in but also frequent frustration in banking profits on those I'd prefer to grow more (e.g., Blue Circle Cement (CIL), Mega'Bus (SGC), MIke & TErry Lawnmowers (MSCC), Norse Hydro-Elek (NHY & YARO), TotElFina (FP)) just to fund foot-in-door stakes in under-rated firms (like British Goodrich (ISYS), Brush-Wellman (MTRN), Drezdner Bank (MRCH), Ivanhoe (TRQ), Sigarex (STSI) & Tighten Wheels (TWI)) before their prises shoot out of reach.

    3) My mother has oppozite problem: despite paying for life-saving operation & krippling nursing-home fees, she's loaded. But I'm hard put to explain simple arithmetik that she BETTER OFF keeping kash on depozit @ ZERO INTEREST than fnanshal suiside of more fixed interest bonds, where she'd lokk in guaranteed loss: held to maturity some of this loss is rekovered by koupon payments but how many of us are alive when some bonds mature?.

    4) Exseption is Indexed Bonds. Here in England they've koupons from 0⅛% to 4⅛% but behave like 3½% bonds (depending on your inflation prediktion for next few years), roughly mirroring their fixed brethren's yields for each maturity year. Strip out the inflation estimate & some of them shew negative yields to maturity as these are over-prized too. But (a) inflation's NOT stripped out - government pays you that 3½-odd yield; (b) even pension funds don't hold to maturity & (c) market jitters re inflation &c make prising anomalies so when you buy in the troughs & sell @ peaks you're making 35%, never mind 3½%.

    5) My son's @ university & makes not enough money @ holiday jobs; I'm funding a divorse too, so having spare kash ain't eazy. If you've already a war-chest you've been very lukky or klever or saving a longtime.

    6) The answer to 10% or 33% &c lies in your own experiense of how often & how quiqqly you want to bag buying opportunities before they vanish - blink & you miss them!

  • Report this Comment On September 14, 2013, at 5:14 AM, FREEHIKER wrote:

    In one article, The Motley Fool strongly advocates leaving dvivdends in pace to compound and grow. Now, you are telling to pull them out and hold in cash, in case something good comes along. Unless I am missing an option in my buyer's sheets, you cannot do both. At least, I have not seen a partial reinvestment option.

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