Are any investments safe?
Consider this: Even if your investments are cash investments, fully insured by the FDIC, future inflation could depreciate your cash by the rate of inflation, less the meager returns you receive.
The key to investment success is a well-balanced portfolio, reflecting current economic and financial conditions.
To help you deal with the current gloom and doom concerning investments, let’s examine some investment options, including equities (stocks and stock funds) and fixed income (bond and bond funds).
First develop an investment policy
An investment policy is a set of guidelines for managing investment assets that is consistent with your investment goals and the realities of investment markets. An investment policy determines the asset classes in which you will invest, as well as the minimum and maximum percentage of your total portfolio, which may be allocated to each asset class. The asset classes you chose and their allocation ranges will depend upon your age, risk tolerance and your total financial resources.
Equities or stocks and stock funds
The U.S. stock markets continue to decline after a 40 percent drop in 2008. Some analysts believe that we are approaching the market bottom. However, when one market indicator, the Price/Earnings (P/E) ratio of the S&P 500, is examined we find that this ratio is still well above the P/E lows reached in previous bear markets.
International stocks, in both developed and emerging markets, also continue to decline and the dollar has strengthened against most international currencies. So what should you do? I recommend that you first examine your investment policy. Based on current market conditions, it appears wise to be at the low end of your equity allocation. A lower allocation keeps you invested in the market, while protecting your portfolio from the ravages of a continued market decline. For my clients, with typical investment policy equity allocations between 20 percent and 65 percent, current allocations to equities are between 20 percent and 30 percent.
Fixed income or bonds and bond funds
Bonds and bond funds also typically declined in 2009, as interest rates fell and concern over corporate defaults mounted. In 2009, well-selected bond funds should provide positive returns. With this in mind, I recommend that your asset allocation for fixed income be near the high end of your allocation, as defined in your investment policy. For my clients, with investment policy fixed income allocations between 25 percent and 70 percent, their current allocation to fixed income investments is typically between 60 percent and 70 percent.
Three classes of bond funds will likely yield positive returns in 2009. The first is short-term bond funds. With interest rates at historic lows, future interest rate changes will likely be upward. Short-term bond funds will suffer less price loss when interest rates rise, yet have yields that are only slightly below intermediate and long term bond funds.
Another category to consider is funds that invest in Treasury Inflation Protected Securities (TIPS). They offer the same safety of principle as U.S. treasury bonds. TIPS are currently priced to reflect an annual inflation rate of approximately 0.5 percent over the next 10 years. TIPS funds, such a Vanguard’s VPISX, are currently yielding over 5 percent annually. When inflation increases, TIPS will provide a yield that increases with the rate of inflation. TIPS will also increase in price if there is an expectation of higher future inflation rates.
You may also wish to consider funds that invest in Government National Mortgage Association (GNMA) bonds. While these are typically intermediate term funds, they are backed by the U.S. government and have virtually the same risk of default as treasury bonds. GNMA bond funds currently yield around 5 percent. While fund prices could decrease if interest rates rise, these funds provide good current yields and safety of principle.