Investment markets have been volatile lately as many investors are concerned about maintaining the value of their holdings.
Market news, punditry and prognostications have been leaning negatively in recent months due to uncertainty. Understandably, nobody wants to give away investment gains they’ve achieved, so quite a few investors are “flocking to safety” right now.
How much of your portfolio should be positioned for safety versus growth depends on your investment needs, tolerance for risk and a number of other factors. I never advise making wholesale portfolio changes as a reaction to market events.
However, I do agree with the importance of having a safety component of your investment portfolio as part of a comprehensive investment strategy.
I recommend absorbing market risk within the equity or stock portion of a model investment portfolio to capture gains and foster long-term growth. Consequently, I prefer the safety component of my investment portfolio to be truly safe.
Bonds are typically viewed as safer alternatives to equity or stock holdings, but their creditworthiness depends entirely upon the issuer. The safest issuer is still the government of our United States of America. Whenever the USA has guaranteed payment on an obligation, it has always been met. There is great confidence that will continue to be the case.
Likewise, the interest rates on U.S. government debt obligations are rather unattractive because the investor is absorbing very little risk.
At the opposite end of the spectrum, consider a company like Ford Motor Co. Its corporate debt was downgraded this week by Moody’s Investors Service to “junk” status, but there are certainly lower and more risky ratings beneath that rating level.
To raise capital, Ford must offer investors an even more attractive interest rate to make up for the risk they are absorbing. In the event that Ford runs out of money and goes bankrupt, corporate bondholders would have to get in line with all other debt issuers based on the seniority of Ford’s debts. Investors might risk losing some or all of their original investment in such an unfortunate situation.
So much for a safe option for your cash!
While using corporate bonds or bonds with lower credit ratings might offer higher interest rates than the alternatives, the balance between the inherent risk and potential reward rarely makes sense for most investors.
Consider instead using an FDIC-insured Certificate of Deposit, or CD as it is more commonly referred. CD rates are terrible as well right now, but they do offer protection through the FDIC. Stated simply, if the issuer of a CD goes bankrupt, the U.S. government will intervene and return your original investment back to you.
Another appealing option for many is a High Yield Savings account. Most large banks such as Capital One, Discover, Ally and others offer such an account. They offer a high interest rate that stays high because these accounts compete against each other across big banks, and these accounts are also FDIC-insured.
You might only be able to make six transactions each month in such an account, but that shouldn’t hurt you if you learn to use the account properly. It could serve as a great storage location for cash that you want to keep liquid and safe but still maintain a competitive rate of return.
Above all, we need to maintain a balance between the safety and growth aspects of our investment portfolios. Don’t forget about continuing to ensure future growth while seeking to preserve your hard-earned investment dollars.
Please consult a tax advisor for how the advice in this article pertains to your personal financial situation.