Cents and Sensibility
Guy Steele
Question: I was burned by the stock market over the last couple of years and have all of my cash in CDs and money market accounts. Now that the war with Iraq is over, I think the market may go up later this year. Should I invest now or keep my money where it is? There is a better
alternative than
parking your moneyAnswer: You may feel that putting your money in certificates of deposit and money markets is a safe way to "ride out" the turbulent markets. And in the current political and economic environment, the stability of principal offered by these vehicles is indeed a factor to consider. And yet, you'll need to be careful not to keep too large a percentage of your funds in these types of investments for too long. Why? Because you could run into problems you may not have considered.
To begin with, keep in mind that the longer you park your money, the less safe it is from the threat of inflation. In today's low interest-rate environment, many fixed-income vehicles offer returns that barely exceed the inflation rate -- if they exceed it at all.
Your first thought might be that inflation isn't much of a threat today. And it's true that, over the past several years, inflation has been quite mild, especially in contrast to the period of the late 1970s and early 1980s. However, although inflation has been low, it hasn't disappeared entirely -- and, over time, even a low rate of inflation can add up, eroding your purchasing power. For example, in just 20 years, an annual inflation rate of 4 percent would drive the value of a dollar down to 44 cents.
Clearly, you can't afford to tie up too many of your investment dollars in vehicles that won't keep you ahead of inflation. But there's another danger of "parking" your money for too long -- the "opportunity cost" you pay for staying on the investment sidelines. Every "bear" market in history has ended -- sooner or later -- and the biggest gains in stock prices have usually been recorded in the first few months of a recovery. (However, you must remember that what's happened in the past doesn't necessarily indicate future results.) If you are still parked in money market accounts and CDs when the stock market turns around, you might miss out on growth opportunities.
So, given the dual needs of staying ahead of inflation and staying invested in preparation for a recovery, when should you think about pulling out of the parking lot? After all, neither you nor anyone else can predict the future course of the financial markets.
Here's the answer: Don't park, diversify. By keeping your investment dollars in a wide range of high-quality stocks, bonds, money market accounts, CDs and government securities, you can reduce the effects of market volatility and give yourself more chances to succeed.
Of course, your exact mix of investments should be based on your risk tolerance, your long-term goals and your time horizon. But even if you are, by nature, a conservative investor, you still won't want to keep too large a percentage of your assets stuck in fixed-rate vehicles. To achieve your long-term objectives, such as a comfortable retirement, you will more than likely need some exposure to stocks -- the only asset class that, over time, has significantly outperformed inflation.
So, look over your investments carefully. Make changes when you need to keep your portfolio properly balanced, according to your needs and goals -- but don't get stuck in "park."
Guy Steele is a financial planner and head
of the Pali Palms office of Edward Jones. Send
planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, HI, 96734,
or by email at: gsteele2@pixi.com