Stocks have provided strong returns around the world this year, but evidence shows many people investing on their own are putting the bulk of their savings in cash and bonds. Equities have nearly reached their 2007 record highs, but most are simply too scarred from the Great Recession and the technology bubble that came before it to feel comfortable investing in stocks.
A recent Wall Street Journal article, Corporate Bonds Draw Stampede, noted that companies were on track to sell over $1 TRILLION in bonds in 2012 at an average interest rate of 3.2% – an all-time low. Over the past 30 years, interest rates on these same bonds averaged about 7.2%.
Because of the demand, even companies that don’t need the money right now are issuing bonds because the borrowing costs are too low to pass up; and this should be a warning sign for investors. When interest rates eventually rise, prices of recently issued long-term corporate bonds will fall.
Principal loss isn’t the only risk of a cash and bond-only portfolio.
One of my clients recently brought in a hospital bill she found while helping her mother clean out files. It was for her sister’s birth at Maple Knoll Hospital in Glendale, in November, 1951. The total charge for the hospital room and medical attention for mother and baby for 3 days was $72.50.
Granted, this was 61 years ago, but today I doubt a mother and child could stay in any hospital for 3 days and make it out without a bill for at least 100 times the cost.
Inflation doesn’t get much attention these days because the recession kept many companies from raising prices. Before that, we had inexpensive imports from places like China keeping our cost of living low.
But some things, such as education, gasoline, and health care, have all gone up significantly in cost while clothing and electronic imports have gone down. In the future, it’s also unrealistic to expect emerging countries to be able to keep wages to workers exceptionally low as their economies develop, which will put pricing pressure on goods exported to the US. When you throw in the long-term impact of global interest rate policies over the past five years, you have a recipe for higher prices – and probably more inflation than we’ve experienced over the past two decades.
The average retirement lasts over 30 years. Even if your money is safe in your mattress, you aren’t protected from the slow but sure erosion of what that money can buy you. While stocks are scary, and cash and bonds feel safer, you really need all three in your long-term plan to keep your financial plan in balance.
The day-to-day ups and downs of a stock portfolio are evident and can cause you stress, but cash and bonds have risks of their own. They’re just the dangers you don’t see.