When to hold stocks, bonds or cash
November 7, 2013
The most common mix of investments I see in investor portfolios is some combination of stocks and bonds.
Stocks are small segments of a public company (called shares) of which you buy ownership, and bonds are simply IOUs from some entity.
Investors usually hold both, but it is not always prudent to hold both, or at least your allocation of these two asset classes should vary according to the economic environment around you.
Simply put, there is a time to own an asset and a time to not.
Stocks are the place to be during inflationary periods, and when the economy is looking to improve, stocks prices will generally rise. Think of stock prices like the price of a Starbucks coffee. The more inflation we see, the more likely the price of that cup of coffee and that share of stock you own will rise with it.
By a stock price rising along with everything else, stocks can help protect you from the lost purchasing value of the money in your wallet during times of inflation. The rise in share price helps offset your having to spend more money on your groceries.
Bonds, on the other hand, tend to perform poorly during inflation and in fact, can be very damaging to one’s investment balances when inflation is climbing.
Bonds are just IOUs, debt by any other name, and during inflation, interest rates usually rise along with the price of everything else. Unless your bond has a variable interest rate, and few do, your end up being locked into a fixed rate while the rates around you go up. Not a good recipe for a successful investing plan.
Most investors own stocks and bonds as the belief is that one tends to offset weakness in the other, but there are times when both assets will fall in value, and the 2009 crisis was one of those times. Both bonds and stocks got hammered as a worldwide sell-off of all things took place.
At such times, cash was one of the only places to be, and anyone who sat on cash most likely didn’t lose a dime.
Where should investors be right now, and how much of each should you own?
It depends on what one believes is in our economic future.
If the Feds continue to print money and increase the deficit, interest rates will likely climb sometime in the future, and that means stocks will fare better then bonds. If, on the other hand, you believe the U.S. will get its financial house in order, stop borrowing and printing money to pay its bills, bondholders will most likely be rewarded as well or better then stock buyers. If another 2009 crisis is around the corner, then placing more money in plain old savings accounts (which is the “cash” part of the equation) will again most likely be the best place to park your money.
By better understanding what policies Washington will undertake in the future and what effects those policies will have on the economy, you will have a better chance at successfully placing your money in the asset class that will perform the best because of such policies.
This article expresses the opinions of Marc Cuniberti, who hosts “Money Matters” on KVMR FM 89.5 and 105.1 FM on Thursdays at noon and syndicated on over 30 radio stations throughout the US.