Anyone who lived through the go-go market of the late '90s remembers a time when investing inmoney market funds meant leaving money on the table. You could've put your money in just about anystock and, with very little knowledge of the market, made money.
Today, you shouldn't put a dollar in the market unless you understand all its wacky nuances so the smartest guy in the room probably has his savings in money market funds.
Thank Mr. Greenspan for that dichotomy. In this rising interest rate environment, there arevery few safe places to park your money until things settle down. And many investment theories ofthe past just don't seem to work today.
For instance, there was a time when long-term bonds were the safe way to go. Not today, asshort-term fixed income is best thanks to interest rate uncertainty. "You need to be in financialvehicles that will grow when interest rates go up," says Herb Daroff, a CFP and JD at BaystateFinancial Services in Boston, Mass. "So you actually may be better off in a savings account thanlocking into a CD."
Bet you never thought you'd hear that.
But just doing nothing and staying the course might not be the best way to handle this, mainlybecause we're looking at 18 to 24 months of unknown market conditions. "It might make sense toreallocate your portfolio or look at different methods of diversifying against risk," suggests DavidTysk, a senior financial adviser with American Express Financial Advisors in Minneapolis.
Here are some suggestions of where you can consider putting your money until
Chairman Greenspan andthe powers that be figure out what they're doing.
First determine your interest rate exposure, says Lane Jones, a CFP and COO at Evensky andKatz in Coral Gables, Fla. That exposure is called the
of your bonds or bondfunds. Duration is the change in the value of a fixed-income security that will result from a 1%change in interest rates, and it's stated in years.
As an example, let's say you have a bond with a five-year duration. That means the bond will dropin value by 5% if interest rates rise 1%. In turn, the bond will increase in value by 5% ifinterest rates fall 1%. So if interest rates go up, the price of your bond goes down. The longeryou hold the bond, the lower your price can fall and that squashes your return. So the shortertime you hold the bond -- or bond fund -- the less chance you have of the price falling.
So if you expect interest rates to go up -- which most pros do at this point -- you'llwant to decrease your duration. Bond funds with a lower duration have more protection againstinterest rate increases, notes Jones. That's because they invest in short-term securities. The samegoes for your bonds. If you hold shorter-term securities, your exposure to price drops is limited.In addition, your money will free up faster so you can move it into another, better-priced bond.
Read the prospectus of either your bond or bond fund and figure out where you stand.Morningstar.com lists the duration of bond funds, too. Then decide if you want to make a change.
On the fund front, if you're in a fund that has a duration of, say, 10, consider another fund with alower one. The
PIMCO Low Duration hasa duration of 1.78 years and the
Thornburg LimitedTerm Muni fund has a duration of 2.85 years, according to Morningstar. With durationsthat low, your exposure to interest rate increases is diminished.
You might also consider Treasury Inflation-Protected Securities, or TIPS. TIPS are identicalto Treasury notes and bonds except that the principal and coupon payments are adjusted to compensate for theeffects of inflation.
Jones suggests the
PIMCO Real Returnfund and the
Vanguard Inflation ProtectedSecurities fund.
Now that you know how to adjust your fixed-income securities, what about your equity holdings?
Granted, as the Fed starts hiking rates, the economy could potentially start slowing down. Butbecause of the interest rate risk, "large-cap stocks may actually end up to be more stable thanlots of bonds," says Daroff.
Equities are more stable than bonds? "Never!" cries my 99-year-old uncle.
Sorry Uncle Charlie, but it may be true for now.
And if you happen to be in bonds for the income, don't discount dividend-producing stocks -- especially when certain dividends qualify for the 15% lower tax bracket -- because they might actually be abetter way to go.
As an example, let's say you got $1 of interest from a bond. At the regular tax rates that top out at 35%, you'll take home 65 cents. But what if, instead, you got an 80-cent dividend. At the 15% rate,you'll end up with 68 cents in your pocket.
"It's not what you make. It's what you keep that matters," reminds Daroff.
And to continue knocking down all the investment tactics you learned in the past, consider movingsome money overseas for a bit. While it may be blasphemous to say that the U.S. market may not bethe safest place in the world right now, unfortunately, it's the reality.
The valuations are better overseas and enhanced appreciation on international currenciescan only help your investments, notes Jones.
So revisit your international equity allocation and consider sending a bit more overseas for now.And if you don't have any money invested internationally, now's the time to think about it.
Simple but Safe
If the above options are not for you, hop into a money market or CD for a while. Especially if you're just starting to save or you'll need money in the near future, albeit forcollege or your child's wedding. Get it out of the uncertainty and keep it safe.
Besides, money markets are a great investment right now, says Tysk. More than a few industry players are now offering 3% on accounts. CDs have a yield of greater than 4% with no risk vs. the bond market, which is chock full of risk because ofrising interest rates.
So throw out everything you've learned for a while and take cover. You'll save yourself moneyand no doubt your ulcer will thank you as you clench your teeth through these uncertain times.
Tracy Byrnes is an award-winning writer specializing in tax and accounting issues. As a freelancer, she has written columns for wsj.com and the New York Post and her work has appeared in SmartMoney and on CBS MarketWatch. Prior to freelancing, she spent four years as a senior writer for TheStreet.com. Before that, she was an accountant with Ernst & Young. She has a B.A. in English and economics from Lehigh University and an M.B.A. in accounting from Rutgers University.