Tag: Bonds

Is your money going in the right direction?

An acquaintance recently asked me how his money should be invested.  With banks paying virtually zero on savings, it’s a question on everyone’s mind.  Should he invest in stocks or bonds? If it’s stocks, what kind: Growth, Value, Small Cap or Large Cap, U.S. or Foreign?  The same can be asked of bonds: government or corporate, high yield or AAA, taxable of tax free?  That’s a question that faces many people who have money to invest but are not sure of where.

It’s a dilemma because we can’t be sure what the future holds. Is this the time to put money into stocks or will the market go down? If we invest in bonds will interest rates go up … or down? How about investing in some of those Asian “Tigers” where economic growth has been higher than in more developed countries?

There is no perfect answer. We are not gifted with the ability to read the future. And what is this “future” anyway? Next week? Next year? Or 20 years from now when we will need the money for retirement?

We know that generally, people who own companies usually make more money that people put their money in the bank. Another word for “people who own companies” is “stockholders.” That’s why, over the long term, stockholders do better than bondholders. On the other hand, bonds produce income and are generally lower risk than stocks. So my first answer to the question I was asked is: invest in both stocks and bonds.

Choosing the right stocks and bonds is a job that is best left to professionals. That’s the benefit of mutual funds. Mutual funds pool the money of many investors to create professionally managed portfolios of stocks and bonds. They are an easy way of creating the kind of diversification that is important for reducing risk.

To circle back to the original question our friend asked: the answer is to create a well diversified portfolio. We know that some of the time stocks will do better than bonds, and vice versa. We know that some of the time foreign markets outperform the U.S. market. We know that some the time Growth stocks will do better than Value stocks. We just don’t know when. So we select the best funds in each category and measure the over-all result. With so many funds to choose from, the smart investor will get help from a Registered Investment Advisor like the folks at Korving & Company.

Call us for more details.

A Client Asks: What’s the Benefit of Inflation?

One of our retired clients sent us the following question recently:

“I can’t understand the FED condoning and promoting any inflation rate. To me inflation means that the value of money is simply depreciating at the inflation rate. Further, any investment paying less than the inflation rate is losing money. A quick review of CD rates and government bonds show it is a rare one that even approaches the promoted 2.25% rate. It seems to me to be a de-facto admission of wanting to screw conservative investors and forcing them into riskier investments… Where is there any benefit to the financial well-being of the ordinary citizens?”

I suspect that there are a lot of people who feel the same way. It’s a good question. Who wants ever rising prices?

Here’s how I addressed his question:

Let me answer your inflation question first. My personal opinion is that 0% inflation is ideal, and I suspect that you agree. However, lots of people see “modest” rates of inflation (say 2%) as healthy because it indicates a growing economy. Here’s a quote from an article you may want to read:

Rising prices reflect a growing economy. Prices typically rise for one of two reasons: either there’s a sudden shortage of supply, or demand goes up. Supply shocks—like a disruption in the flow of oil from Libya—are usually bad news, because prices rise with no corresponding increase in economic activity. That’s like a tax that takes money out of people’s pockets without providing any benefit in return. But when prices rise because demand increases, that means consumers are spending more money, economic activity is picking up, and hiring is likely to increase.

A case can be made that in a dynamic economy you can never get perfect stability (e.g. perfectly stable prices), so it’s better for there to be more demand than supply – driving prices up – rather than less demand than supply – causing prices to fall (deflation). Of course we have to realize that “prices” here includes the price of labor as well as goods and services. That’s why people can command raises in a growing economy – because employers have to bid up for a limited supply of labor. On the other hand, wages grow stagnant or even decline when there are more workers available than jobs available.

But for retirees on a fixed income, inflation is mostly a negative. Your pension is fixed. Social Security is indexed for inflation, but those “official” inflation numbers don’t take food and fuel costs into consideration, and those tend to go up faster than the “official” rate. The stock market also benefits from modest inflation.

Which gets us to the Federal Reserve, which has kept interest rates near zero for quite a while. It’s doing this to encourage business borrowing, which in turn is supposed to lead to economic expansion.  However, the actual effect has been muted because other government policies have been detrimental to private enterprise. In effect you have seen the results of two government policies in conflict. It’s really a testimony to the resilience of private industry that the economy is doing as well as it is.

The effect on conservative investors (the ones who prefer CDs or government bonds to stocks) has been negative. It’s absolutely true that after inflation and taxes the saver is losing purchasing power in today’s low interest rate environment. The FED is not doing this to intentionally hurt conservative investors, but that’s been part of the collateral damage. The artificially low rates will not last forever and the Fed has indicated they want to raise rates. They key question is when, and by how much?

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