Conservative investors are taking pay cuts due to paltry interest rates. If you’re a conservative investor, chances are a large portion of your portfolio is in bank CDs and money markets because of the safety of these investments.
But today’s environment of record-low interest rates and looming inflation make it difficult to get any real return on your money. So how are conservative investors replacing the yield they were used to getting from CDs?
There is a growing trend of conservative investors turning to riskier investments, such as dividend-paying stocks or higher yielding bonds, to increase what they are earning on their portfolio. This is exactly what Ben Bernanke and the Federal Open Market Committee intended with their latest monetary policy known as QE2. In fact, many financial pundits are talking about dividend-paying stocks for this very reason. But conservative investors beware. Moving out on the risk scale without a plan could easily get you burned.
So how should a conservative investor go about constructing a portfolio when sitting in CDs just won’t do? You’ve heard the terms risk tolerance and time horizon but how do you apply them to your portfolio? The conservative investor starts with time horizon. Match short-term needs with short-term investments, meaning if you plan to spend some of your money over the next couple of years, set that amount aside in short-term investments. CDs, even though they aren’t earning much, may be the best spot for this money, but not all of your money.
Now think in terms of layers. The next layer is to move out the scale towards short-term treasury bonds and short-term, high-quality corporate bonds. Consider putting enough here to meet another year or two of withdrawal needs, but be sure to diversify. With those layers in place, you can now look at income producing assets that may come with more volatility. Since you already have several years of your needs met with low-volatility assets, you’ll be able to stick to your plan when you do see fluctuations in the value of your investments. What goes here? Ideas might include international bonds, preferred stocks, and the dividend-paying stocks everyone is talking about.
Finally, keep in mind that you would do well to keep at least a small portion of your portfolio focused on growth. After all, you want to stay ahead of inflation and taxes over the years. This is where having a diversified portfolio with stock exposure and perhaps other assets such as real estate and commodities can be beneficial.
It may be the right time for conservative investors to look beyond traditional CDs, but following a well-thought-out strategy is essential to maximizing the likelihood of success.