I’m getting more and more questions from nervous investors asking if it’s time to take profits and sell stocks in favor of fixed income investments such as money markets, CDs or bonds. The stock market has had a nice run over the past few years and certainly seems overdue for a rest. Add to that the recent events occurring in the Middle East and people have a good reason to be nervous.
It’s impossible to make short-term market predictions. There is no way to know what the stock market will do today, tomorrow, next month. But looking out over the next three to five years, it’s my opinion that stocks are far more likely to deliver higher returns than investments in fixed income securities. Here’s why:
- Federal Reserve Policy. While the fed is tapering off its monthly bond purchases, it continues to support lower interest rate strategies by maintaining a feds fund rate of near zero percent.
- Improving Economy. The U.S. economy continues to improve, albeit at an anemic pace. This slowly improving economy appears to be just right for a strong stock market.
- Improving Jobs Market. While unemployment is still way above normal, it is improving. Significant unemployment has helped keep inflation at bay and is one of the reasons the federal reserve continues to provide economic stimulus in the form of low interest rates.
- Historical Low Interest Rates. Interest rates remain near historical lows. I do expect interest rates to rise over the next three to five years. If I am correct, fixed income investments, particularly bonds, will face “headwinds”. Remember, as interest rates rise, bond values fall.
- 80 Million Baby Boomers. A large segment of the adult American population is headed for the retirement exits and they’ll be looking for a place to invest their retirement money as a replacement for their paychecks. They will quickly find that the interest offered from fixed income investments will fall far short of their monthly bills and they’ll look for alternatives such as dividends from blue chip stocks. They’ll find yields of fifty to one-hundred percent higher in good solid dividend-paying blue chip stocks.
Recommendations
For retirees and pre-retirees (those retiring within 5-10 years): Keep five to ten years (or more) worth of annual cash flow needs in fixed income securities and invest the balance in high quality, blue chip dividend-paying stocks. To minimize single-company risks, you’ll want to hold a minimum of twenty different companies and periodically rebalance them taking some of the profits of the best performers and buying additional shares of those that lag over a given year.
For other investors: Use fixed income for expected short-term cash needs (a new car?) plus a minimum of six months’ worth of monthly bills. Overall, consider holding 10% to 20% in fixed income as your cushion and invest the balance in stocks.
Yes, the stock market can be a very rowdy place to invest but by taking some precautions to protect your short-term needs for cash, it’s an odds-on bet to give you higher returns than alternative fixed income investments. Develop your plan and try to enjoy the ride!
Consult your advisor before acting on this advice.