Stock Market Conundrum

My previous blog suggested that new ways of investing are needed to be considered because of the very low interest rates. Here is a continuation of that discussion.

The theory behind splitting your portfolio into fixed income and stocks is to have diversification which is intended to reduce risk. The components of a diversified portfolio are designed to offset each other so the portfolio would not be subject to extreme losses. However that also applies to gains, so the portfolio grows at a pretty even pace. The fixed income portion is intended to provide reasonable and predictable cash flow with the principal being fully returned if the CDs or bonds are held until maturity and there is no default by the bond issuer. The stocks will pay dividends that are usually somewhat lower than long-term interest rates but they are expected to increase in value over a reasonable long-term period.

Now comes a conundrum. CD rates have plummeted and are even less than half of the inflation rate. Long-term bond rates are not much more than the inflation rate and many blue chip stock dividends exceed those bond rates. Also, bonds have become difficult to buy, with mutual or index funds a much easier way to invest in bonds. However, bond funds fluctuate in value and do not offer an exit at any time for the amount invested. This also means that fixed income is not what it has always been: reliable interest payments at above inflation rates plus safety of principal. On the other hand, stocks, with the exception of some super high tech companies and a few others, have become reliable dividend payers and while the stock values fluctuate greatly, they have increased over reasonable periods.

Let me talk about what I mean by “reasonable periods.” As I use it, it refers to a minimum of seven years but better for ten years. Accordingly, I do not recommend stocks for anyone if their time horizon is less than seven years. Also, when I say “investing” I really mean the goal should be for your long-term financial security which should be at least a seven to ten year period.

Now there are always exceptions, but my guidance presented in these blogs is general advice. People with circumstances different than the norm would need to adapt what I say but I am very confident that what I am suggesting is good advice for most people in the group I am addressing.

There are other ways to invest, and other choices besides fixed income and stocks, and within each category, including bonds and stocks, there are many variations. Also, people with financial planners and investment managers should defer to their advice which is based on a more informed and thorough understanding of their client’s overall situations. And of course, no investments should be made without having a plan along with goals to guide you.

Investing is complicated, but there are some basic premises I believe everyone should understand, and my blogs are intended to do that. Because it is complicated I provide a stern warning that no one should invest in anything that they do not fully understand how they could make or lose money on that investment. Following this advice will remove some of the complications because then you would not be investing in something that cannot be clearly explained to you. This is presented for your consideration and does not represent my advice about how you should invest.

If you have any tax, business, financial, leadership or management issues you want to discuss please do not hesitate to contact me at [email protected].