We’re drawn to the idea of a safe investments because nobody likes to lose money. Over the past few years investors have turned to bonds, income stocks, and gold for safety. It paid off until now, because safe investments don’t last forever.
Where safety is concerned, the term safe investments is an oxymoron. They don’t exist. There are safer investments, though, and for a small window of time they pay off. To find them, it helps to dig into those old safe investments we’ve heard about the past few years and find out why each is no longer safe. To do that, you need to understand the risks and why investors were buying it.
Long Term Bonds
“There’s safety in bonds” is the call when the stock market drops. Long term bonds and bond funds were the safe investment for decades because interest rates were falling. The 10 year Treasury rate peaked at 15.32% in ’81 and hit a low of 1.53% in ’12. That’s a long way to fall over a very long period. Almost long enough to be habit-forming.
That’s thirty-two of the best performing years for bonds. But now is definitely a case were history should not be your guide. It’s not limited to treasury bonds either. The same applies to every long-term bond. You can throw any historical bond fund performance out the window, too. None of it matters now that interest rates are rising. It could be decades before we see that type of performance out of long-term bonds again.
So what’s the alternative? Sadly, you’re stuck with shorter term investment options like short-term bonds and floating rate bonds, for now. The yield is terribly low, but given enough time, will rise to an acceptable level. When interest rates ever hit 15%, I guarantee that long-term bonds will be a safer investment again.
Utility Stocks
If you own utility stocks or other slow growth, high dividend stocks, it’s probably because you want less volatility and more income. These income stocks have been in high demand, thanks to low-interest rates. Investors still want income, so these stocks have become bond substitutes in many portfolios.
Well, stocks aren’t bonds and have very different risks. But if enough people treat them as bonds, they start acting like bonds. Yet, by doing so, it changes the risk profile of the portfolio and for these stocks. For now, what you have is an overpriced volatile stock bound by interest rate risk. Eventually, these utilities will return to their boring low volatile ways, but not until interest rates normalize, when the 10 year Treasury reaches 3.5 – 4%.
There are several alternatives. The first, don’t own stocks for your bond allocation, own bonds like those listed earlier. You’ll have less income but less risk.
The second, if you can handle the volatility, own a dividend growth fund like the Vanguard Dividend Appreciation ETF (VIG) which focuses on companies that have raised dividends at least 10 years in a row. The stocks in this ETF have less interest rate risk since company growth and an increasing dividend is a bigger factor in performance.
Lastly, if your risk appetite is high enough, you can research investments that benefit from rising rates.
Gold
Gold was supposed to be safe. It’s often called end of the world insurance. This makes gold an emotion driven commodity. It’s main uses are jewelry (high emotional attachment there) and taking up storage space for investors and gold ETFs.
Whenever the financial picture is dire, people turn to gold as a safe haven. But like any good bubble, once demand wanes and fear subsides, the gold price levels off and starts to fall. That safe investment becomes risky and that’s exactly what happened to gold.
I’ve never been a goldbug, because I doubt a piece of paper tied to the price of gold will be useful if the world ends. After the fact, the real stuff will probably put your life at risk. Maybe food and protection would be more usefully if there’s mass chaos. So in this case, only own gold if you it helps you sleep better at night. Even then, you’re probably better off owning a farm and a gun.
The general consensus is that certain investments are safe. This disconnect exists because we fall prey to historical bias or ignore the risks entirely. The worst thing we can do is assume an investment is safe – because it worked in the past, it will continue to work in the future. Well, we’re finding out that history is not a perfect guide and these typical safe investments aren’t so safe anymore.
