Smart investment strategies for 2014

Stock market investors certainly received a surprisingly large dose of good cheer in 2013. The S&P 500 produced the best calendar year return since 1997, when the stock market was up 33 percent. However, with corporate earnings and revenue growth mediocre at best, the gains in the S&P were driven by the low-interest policy of the Federal Reserve, an improving economy, and the simple fact that investors had nowhere else to earn income.

Of course, there’s no way to know for certain whether this positive trend will continue in 2014. However, data from Schaeffer’s Investment Research supports continued upward momentum. Since 1975, reports Schaeffer’s, whenever the S&P was up at least 20 percent at the end of the year, the following year the stock market was up an average of 12.84 percent and posted positive returns 82 percent of the time.

Another potential positive for market performance in 2014 is how well investors reacted to the news that the Federal Reserve Board will being tapering its massive bond purchasing program in January. While some speculated that tapering would lead to a sell-off, the stock market rallied instead, likely because the Fed’s move indicates that the economy is finally in recovery mode.

Given the recent economic and market trends, here are a few strategies for investors to consider adopting in 2014:

• Overweight equities. Unfortunately, there is still too much risk for the amount of income to be had in the bond market. It is likely that bond prices will go down and yields will rise now that the Fed has announced that tapering will start this month, which makes stocks even more attractive. At Northstar, we look for equities that pay a meaningful dividend and companies that increase their dividends every year.
• Shorten the maturity of your bond portfolio.  If you own individual bonds in your portfolio for diversification, then examine the maturities of the bonds that you hold. Holding longer-maturity bonds in a rising rate environment means that your interest income from those bonds will be less than prevailing rates.   If you happen to own a fixed-income bond mutual fund, this is even more important. As interest rates rise, the Net Asset Value or NAV will drop in value and you could be subject to losses. We saw this in May and June of 2013 when interest rates spiked 130 basis points.
• Consider the credit risk of your tax-free bonds. You may not know it, but the single state municipal bond fund you’re invested in might include some potentially risky holdings, including Puerto Rico bonds, which are facing another downgrade. Don’t be afraid to ask your broker for a list of bonds held in your single-state bond mutual fund, so you can assess your comfort level with the holdings. It’s also important to evaluate the underlying credit quality of your bonds and make sure you understand what the repayment sources of those bonds are. Essential service bonds for water and sewer for example, might be safer than general obligation debt.