What Are the Best Investments for 2014?

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As the end of the year approaches, many of us are thinking about what 2014 might look like.

How’s the 2014 economy going to be doing? Who’s going to win the midterm elections?

And, most importantly for investors, how are securities markets going to fare? What are the best investments we can make in 2014?

It’s a fool’s errand to guess how a particular stock or mutual fund may perform in the next twelve months. There simply are too many random variables at play to make any kind of informed prediction at such a specific level.

We can, however, look at broad performance trends and consider how those trends may change as the New Year unfolds. Here are a few of our observations.

2014 Best Investments: Stocks versus Bonds

In 2013, stocks and bonds behaved very differently. The S&P 500 is up by more than 28% since the beginning of January. But the Barclays U.S. Aggregate Bond Index, a broad measure of fixed income activity, is slightly down for the year to date.

The decisive phase of this trend was from May to September, as investors sold off large quantities of bonds in anticipation of the Fed starting to scale back its monetary stimulus program known as Quantitative Easing.

The Fed surprised investors by deciding to hold off on tapering, but investors still wonder when (not “if”) that tapering will begin. Rates have been at historically low levels for a long time. The longer-term trend is likely to be upwards, which will make it difficult for bonds to outperform stocks.

Of course, bonds are still an important piece of a prudently-diversified investment portfolio. You may want to consider shorter-duration bonds, which are less vulnerable to interest rate risk, and perhaps favor corporate bonds over US Treasuries for better yield opportunities.

2014 Best Investments: U.S. versus Non-U.S. Stocks

The outperformance of U.S. stocks over international markets is another seemingly durable trend, particularly when we compare domestic equities to emerging markets.

There are many theories as to why this might be the case.

Here’s one thought. Global growth is generally weak, or at least below-average. Emerging markets tend to be the beneficiaries of strong growth environments, but they are also at risk when demand weakens in their core export markets in North America and Europe.

Arguably, the stock market’s impressive gains over the past two years have been driven more by the Fed (quantitative easing) and by strong corporate bottom lines than by top-line growth. Both those factors probably favor U.S. stocks over their foreign counterparts.

Will this trend continue? That’s hard to say.

The earnings outlook is a bit more muted now than it was at the beginning of this year. And investors expect the Fed to start tapering at some point next year.

On the other hand, it’s hard to make a strong case for the kind of growth environment that normally favors emerging markets.

The Best Investments are in a Diversified Portfolio

Trends in the equities market have become choppy during the past few months, with very little sustained leadership among different industry sectors or style categories (like value, growth, large cap, small cap, etc).

In 2013, defensive sectors like utilities and cyclicals like consumer discretionary have each had their day, but as year-end approaches the momentum seems to shift.

In this kind of environment, diversification can be the best strategy. Keep your equities portfolio balanced between different asset classes (sectors, styles and geographic locations). Complement that with whatever fixed-income allocation is appropriate for your goals and risk tolerance.

Over the long term, a smart allocation strategy will likely add more to your performance than guessing what’s going to be up or down over the next twelve months.

What’s your investment outlook for 2014?