Is the Stock Market Cheap?

The last time I checked, there were only a few basic places to invest money. The first place is cash. This includes checking and savings accounts, certificates of deposit and money market funds. In a nutshell, you give the institution your money, they give you 2% and loan it out at 7% making a 5% "spread" on your money. This is the fee they charge you. If you need any money in the next 1-2 years this is the best place to put those dollars because you know it won't drop in value and it's safe.

The second place is in bonds. Bonds are lending instruments where an institution, goverment or corporation borrows your money and pays you interest on that money. At the end of a certain term they give you your money back...hopefully. Depending on the institution you're loaning it to is how the rate is determined. The U.S. Government has never defaulted on their bonds, so obviously you won't receive that much interest from them. If Bear Stearns wants to borrow your money right now, you may want to ask them for a little bit more interest. Bonds are for time frames of 3-7 years. If you're saving for a downpayment for a house in 5 years then this may be the best place for those dollars. But, you should be cautious because you CAN lose principal in time frames of less than three years. You should expect 3-6% over time from bonds.

The final place I can see where to invest your money is in equities or ownership of assets. This can be real estate or stocks. Investing in stocks is buying partial ownership in a business. The reason you start a business is to make money. When you start or buy into a business, all you should care about is the cash in the cash register at the end of the day after you pay all of your bills. This is the money you get to take home. These dollars should have a time horizon of at least 7+ years. You would never start a business and put time, effort and money into it and give up on it or expect to make a huge profit on less time than that, or at least you shouldn't expect it.

Well right now you have the above options. Cash is paying you 2%. Bonds, and specifically the 10 year Treasury, are paying you 3.4% and the earnings of the 500 largest U.S. corporations (the S&P 500) are paying you 7.14%. But, since we're going through a downturn in the economy and possibly a recession, we want to factor in a margin of safety and say that earnings may go down 30% in which case we will only earn 5% at the end of the day in our cash register.

So you have 2% versus 3.4% versus 5%. Where should you put your money? It's that simple.