Economic headwinds are dissipating. Households are deleveraging their debt. We’re even slowly, finally emerging from the housing bubble. The stock market has reflected growth in the economy and corporate earnings. The S&P 500 Index rose by 15 percent through the first three quarters of 2012.
But jobs have not yet recovered, and the Fed has committed to keep interest rates low at least through mid-2015. That has created an environment in which low interest rates on traditional savings vehicles are forcing investors to scramble for yield.
They can’t get it from bank CDs or money market accounts. So instead, many investors are chasing yield by lowering the credit quality in their bond portfolios and extending durations.
As investment advisors, we worry about the eventual consequences of those moves. Remember that as interest rates rise, prices on bonds fall. And with zero yield, interest rates have nowhere to go but up – especially as the economy continues to improve.
This no-yield world dramatically increases the risk levels of the bond market. It’s really important to look forward and think through the strategy of what to do if yields stay down for an extended period.
Everything in your portfolio should have a purpose. When you look at savings, consider the purpose for your bond funds. If the purpose is liquidity, then you have to sacrifice income. If the purpose is income, then you have to trade off stability of principal.
Those are the questions you need to address.
The majority of the people we represent need some money that they can get at without any fooling around. Most of the money is designed for growth and/or income. That’s the tradeoff. They really have to focus on what’s important to them and then act accordingly.
We’re not suggesting you have much more than 60 percent of your portfolio in stocks overall. But, it’s a conversation many people should have with their advisors – not tomorrow, not the next day, but over the next couple of years – as the economy improves and we move on from the no-yield world.