Your financial options and how to weigh safety vs. risk
By Terry Savage January 25, 2012 5:22PM
Cash money and piggy bank. Dollars, finance, business concept.
Updated: May 3, 2013 12:15PM
You have some basic investment choices, and not only do you need to understand how they work, you also need to allocate an appropriate portion of your savings to at last two or more of them.
All of this presumes that you have some savings or retirement investments to work with. So a special note to those who are just struggling to get out of debt. The toll-free number for credit counseling you can trust is (800) 388-2227. That will connect you to the nearest local office of an agency affiliated with the National Foundation for Credit Counseling. Don’t give up. Get help.
Now, let’s start by talking about “chicken money.”
It’s not your imagination. If you’ve been a saver, you’re getting penalized by low interest rates. The Fed has announced it will keep interest rates low — as an incentive to get those with money to stop sitting on it and start investing it. Of course, their policies are primarily directed at banks and large corporations, who together have trillions of dollars sitting rather idly on the sidelines.
Banks and businesses are unwilling to take the risk of lending or investing the money. Banks fear more credit losses are on the way in an economy that refuses to grow. And businesses fear more taxes and regulations, so they are hesitant to build new plants or create new jobs.
They can resist the tide of lower interest rates. But for many Americans who saved up so they could live on their interest income in their retirement years, the current Fed policy of keeping interest rates low is a punishment, not a reward, for their years of savings.
What to do: Resist the temptation to take higher risk — or ignore risk — in order to earn a higher return. Knowing how frustrated you are, some firms will tempt you with “structured notes” or equity-linked CDs or other promises of products that offer higher returns on your money. In too many cases, the salesperson is the one
making all the money!
The Savage Truth: It is better to dig into your principal for living expenses for a few years, than to lose a hunk of your savings to fees, illiquidity, and outright scams!
The stock market
Naysayers will give you a million reasons why the stock market shouldn’t go up. The economy is relatively weak, America has huge debt problems, and the global economy is facing debt shock.
Yet, the stock market has managed to hold its own ground over the past three years, and not go back to its March 2009 bear market low around 6,700. No matter how disastrous the economy, the stock market can rally — as it did between 1932 and 1937, the worst years of the Great Depression.
This isn’t the time to throw in the towel on stocks. The Stock Trader’s Almanac reminds us that in every fourth year of a U.S. president’s term, since 1946, when the market was higher in January of that year, it finished higher for the entire year. So, we’re off to a good start!
That’s not a blanket endorsement of all stocks. You have to pick and choose wisely. But good companies that pay dividends may be a good place for a portion of your money. The global smart money is still coming to America as the relatively safest place to keep their money, despite our well-known problems. And they aren’t sitting in T-bills or bank CDs at near zero percent. They want to earn a return on their money through dividends, and the possibility of stock price increases.
What to do: Depending on your stage in life, risk tolerance, and need for cash, you’ll want to have a portion of your money in dividend-paying stocks. Either consider an Equity-Income mutual fund (there are many, search at Morningstar.com). Or read Chuck Carlson’s book, “The Little Book of Big Dividends,” (for which I wrote the preface). There’s a list of best dividend payers at his website, www.bigsafedividends.com.
The Savage Truth: The most “difficult” thing to do, the scariest thing at the moment, is often the best thing to do in hindsight. The “crowd” is usually wrong — eventually!
It just doesn’t look like U.S. interest rates are going to rise any time soon. At least, that’s what the Fed is promising. And the trading world seems to agree. Despite credit downgrades and budget worries, the world’s hot money seems to think America is the safest place to keep money on deposit.
As money rushes to buy our government bonds, rates drop. The 10-year Treasury note was yielding more than 3.3 percent a year ago; now it’s yielding less than 1.90 percent.
Just remember that when interest rates do rise — and they will at some point — the market value of your bonds will fall. That’s because in a rising rate environment, no one wants to pay face value for your old, low-yielding bonds. So you could be forced to sell bonds at a huge loss if you need the cash.
Because of this “interest rate risk,” longer maturity bonds pay higher yields — tempting you to forget that risk. Buying a 10-year bond is a bet that interest rates won’t rise dramatically in the next 10 years. Is that a bet you really want to make?
Similarly, lower quality credit bonds offer higher yields — but will the borrowers stay in business to pay out the promised rate? Municipal bonds may offer tempting, higher, tax-free yields. But will these states and municipalities be able to raise taxes and revenues to pay off in the end? Those are the questions you must ask yourself before investing in bonds.
What to do: Stick with shorter maturities, and higher quality bonds. “Ladder” or stagger maturities so that all do not mature at once. Use a top quality bond fund that is managed by a professional instead of buying individual bonds, where prices are hard to decipher and commissions may be large. Or decide that you’d rather accept nearly zero yield in short-term CDs that give you liquidity and flexibility, than the risk of being locked into low interest rate bonds for many years.
Be diversified. Hedge your bets
Overall, given all the special uncertainties of this election year, you’ll want to be diversified among these three categories — appropriately for your age and stage of life. It sounds like waffling, but in times like these why would you take the risk of moving heavily one way or another, unless you have a very high risk-tolerance?
You might want to hedge your bets on a balanced year in the markets by owning some gold as a hedge. Long-term, I expect it will move higher, much higher, as we continue to devalue our currency and borrow money to finance our deficits. Adding paper money does not cure deflation; it only sets up the risk of future currency devaluation.
What to do: Now, at over $1,650 an ounce, gold has become a volatile speculation — so if you buy at these levels, or on pullbacks, you’ll need financial staying power and strong long-term conviction. Interesting note: The price of gold bullion, which can be traded by purchasing exchange traded funds (ETFs) such as GLD, immediately reflects global gold prices. But in recent years, share prices of gold mining companies have lagged bullion prices. For patient investors, those better quality mining company shares may provide better long-term growth — and dividend — possibilities. Search Morningstar for mutual funds that purchase shares of gold mining companies.
A final note: These are general guidelines to the possibilities for investing in 2012. If you aren’t willing to do the work of evaluating the possibilities and managing your emotions, please consult an investment adviser or financial planner. A good place to start is with a Certified Financial Planner (www.cfpboard.org) or a fee-only planner (www.feeonly.org). As always, trust your instincts and always ask about costs, liquidity (ease of getting out of the investment) — and how the adviser is being compensated for this advice.