Thursday, December 27, 2012

Should you invest in stocks or bonds?

Are you investing your savings in stocks, or bonds?

According to a Dec 27 CNN Money article, investors yanked $150 billion from the stocks, mutual funds and ETFs for the third year in a row.  Where did the savings and/or investments go, or end up?

The article mentions that 'Baby Boomers' - who represent the largest group among retail investors - had shifted their investments out of stocks and into bonds much earlier than usual, as they head into retirement.  It also suggests that this generation was prompted to take action because they had previously experienced their portfolios rocked by the dot-com crash and the financial crisis.

Of course, it's also possible that their investments were re-allocated to other 'investments', like cash in the bank, home renovations, discretionary spending (holidays, a new car, etc.).  That would be bad news for Baby Boomers saving for retirement!

Here's the kicker: In only 2012 YTD, these Baby Boomers may have 'lost' a potential return on investment in the 'high teens', perhaps even ~20% (with re-invested dividends).  The S&P 500 had rallied 13% Jan-Nov 2012.

Even the stodgy Dow index of 30 blue-chip stocks has gained nearly 10% YTD (before re-invested dividends).  Note that if you had invested in a small basket of e.g. 10 Dow stocks and say you were 'lucky enough' to have included Bank of America (NYSE:BAC), but not Hewlett Packard (NYSE:HPQ), you would have generated a return quite similar to - or even greater than - the S&P500 YTD rally mentioned above.

According to The Street, the best performing bond fund YTD for 2012 has been Wells Fargo Advantage CoreBuilder (WFCMX), with a return of 14% and an expense ratio of 2.11%.  This top-performing bond is managed for Wells Fargo by Michael J. Bray, who has managed to deliver a return since inception of nearly 10%.

A Baby Boomer looking to move cash out of stocks or ETFs would probably be well served considering this bond.  In fact, WFCMX may be one of the best 'parking spots' for your investment if you're looking to help mitigate risk, and perhaps avoid the stress of the stock market volatility.

Note a couple of important points:
1.  WFCMX is the only bond fund that delivered a double-digit return, YTD 2012.
2.  The expense ratio at >2%, compounded, will reduce the actual return commensurately.  [When you have a long position in equity (i.e. you own the stock), there is no expense ratio]
3.  WFCMX seeks total return consisting of current income and capital appreciation. The fund invests at least 60% of its net assets in municipal securities that pay interest exempt from federal income tax [but not the alternative minimum tax ("AMT")], up to 40% of the fund's net assets in municipal securities that pay interest subject to federal AMT, up to 40% of its total assets in below investment-grade municipal securities and up to 10% of the fund's net assets in corporate debt securities. WFCMX pays a healthy dividend.

Particularly of interest in the CNN article is this excerpt:
"While individual investors have been shunning the market, institutional investors, such as hedge funds and pension funds, have been significantly adding to their stock positions. They've poured more than $80 billion into stocks so far this year."

It is possible that all the strategies above may end up positive, and I certainly hope that will be the case.  If you remained invested in quality S&P 500 or Dow stocks, your YTD gains would easily absorb recent volatility, e.g. during political wrangling about the Fiscal Cliff and Debt Ceiling.  If you moved your investments out of stocks and into bonds, I hope that the summary above will assist with planning when you speak with your financial advisor.  

The 'smart money' is getting into stocks (i.e. the people who do this for a living, like hedge funds & pension funds) while small investors - who are spooked - are getting out.  Both may prove correct, medium term?  If you are a smaller investor unable to accommodate the turmoil and ups-and-downs of the stock market, make sure you are educated, know your costs, and find a good alternate home for your investments.

Whatever you and your advisor decide, please aim to achieve personal financial literacy... and make sure you continue to spend less than what your earn!