In grizzly times, be cautious but not frightened
- Article by: ROSS LEVIN
- August 28, 2010 - 9:12 PM
As the thousand-pound brown bear on the Alaskan Katmai coast walked a few feet in front of our lawn chairs I was surprisingly calm. These bears could tear the head off a massive salmon and in three big bites finish off the hapless fish. But they had little interest in doing the same to our family. You may need to be cautious hanging around the largest land-based predator in North America, but if you do what you are supposed to do, you need not be scared.
This seems to parallel the situation we are in with the markets. There are certain places where caution is in order, but there is no need to be frightened. Let me go over some of the things that I am hearing the most and what they mean for you.
'Wall Street is rigged.' While I agree that often some of the large investment banks seem to be making money when the average investor is being picked apart like an Alaskan salmon, a rigged game would mean that only the firms are profiting and you don't stand a chance. I have no intention of defending the investment banks -- I think much of what has happened in that arena is truly indefensible. But that does not means your answer is to avoid long-term investing. While short-term market fluctuations are always a product of emotion, long-term stock market valuations are determined by factors that put the odds back in your favor -- earnings growth, dividend growth and inflation. The current price that you pay affects the size of your return. But over time, company earnings will grow, dividends will grow, and inflation will resurface. Pay attention to worldwide demand for products and services and you can see that, while the world economy currently appears anemic, it still continues to grow.
'You need to be in something safe, like bonds.' If I would have closed my eyes when the bear walked in front of me, it still would have been there. If you want to close your eyes to the current risks that bonds have, it doesn't eliminate them. Any properly invested portfolio should contain bonds. With corporate bonds, you loan to companies. With government bonds, you are lending money to the nation or municipality that you choose.
Bonds today just represent a lousy value. Scared people buy bonds. Johnson & Johnson (JNJ) just borrowed money from investors for 10 years at 2.95 percent. They currently pay a dividend of 3.7 percent. I am not recommending this stock, but simply using it as an example. The dividend from this company has almost tripled over the last 10 years. But 10 years ago, you could earn a much higher interest rate on your bonds. Today, you are hardly getting paid at all.
The biggest risk with bonds is that inflation comes back and interest rates go up. While you may get your initial investment back when the bond matures, your buying power will have been destroyed. You can protect yourself a little by buying Treasury-Inflation Protected Securities (TIPS), but they are not currently paying very well, either.
'This country is headed in the wrong direction.' The worst thing to do if a bear approaches is to turn around and run. Regardless of your political persuasion, you can't sum up the complexity of the issues facing this economy in one sentence. There are several things going wrong with the economy and several things that are going right. It will take a very long time to absorb the jobs that we lost plus create new jobs for a growing workforce. This means that it will also take longer for real economic growth to take hold.
Many borrowers are paying off debts. This means less money is being spent. And while consumers and companies are generally decreasing their debt, governments have been increasing theirs. Oh yeah, we also have wars, environmental issues, huge real estate concerns, increasing tax rates and crippling state deficits.
But this is only a piece of the story. As I previously mentioned, corporate earnings are growing, dividends are increasing and balance sheets look much stronger. We stared down the potential economic depression of a couple of years ago and did not blink. Consumers are spending less, but are still spending. And all economies adapt to changes -- sometimes slowly, sometimes painfully, and sometimes unexpectedly.
Don't beat a hasty retreat. View your money in buckets; short-term money in savings, midterm money in stocks and bonds, and longer-term money in stocks. While you may not be completely comfortable, you will not only survive, but thrive.
Spend your life wisely.
Ross Levin is the founding principal and president of Accredited Investors Inc. in Edina. He is a certified financial planner and author of "The Wealth Management Index." His Gains & Losses column appears on the fourth and fifth Sundays of the month. His e-mail is firstname.lastname@example.org.
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