US stock markets approach near two year highs as economic recovery drive profit growth for companies’ across the board. Certainly exuberance is returning in stocks but taking lessons from the past we should stick to basics and let the markets decide their own course.
The key maize for American investors in 2011 will be to choose between stocks and bonds as the current economic picture fails to provide any clear cut evidence of what we may witness ahead. This may not seem a challenging task for long term investors, even value seekers will get plenty opportunities but short term investors will find it difficult to stay afloat amid sporadic phases of volatility. ( Also Read Value Investing is a Holistic Approach to Reduce Risk )
Investors should hold a little confidence on the back of historic track record of stocks and bonds but they should not ignore investing in precious commodities and real estate. (Also Read Economic Forecasts for 2011 )
Housing prices are still vulnerable to making new lows as home owners are struggling to coupe up with foreclosures. We might see some level of respite for this market in 2011, but it depends on how the employment scenario pans out and it’s not a practical way to think that low prices will attract people to make purchases when they are submerged under debt.
Gold and other precious commodities have yet again proven to be safe heavens amid recent recession and these commodities are holding on to their gains. Forecasting trends in these commodities is not viable at present as the overall economic outlook remains dicey. ( Also Read Which commodities are poised to move higher in 2011? Will it be the Glittering Gold Again? )
From all available investment options, stocks have always performed better for long term investors. The next best performers with low risks are bonds. If we check the historic performance since 1926 to present year stocks have shown an annual return of almost 10% and bonds averaged around 5.5%. (Also Read Investment Strategy Series 2011- How to Invest in Stocks and Bonds Funds )
Dec 12, 1914 is remembered as the worst day for investments as the market crashed ruining thousands. At 24.4% stocks recorded the worst fall ever. A similar scenario repeated on Oct 19, 1987 when the stocks lost 22.6%. It seems the worst is not over yet. During the recent recession many people invested in the market peak at peak levels, mostly on the back of exaggerated exuberance in March 2008 and over a period of three years they lost about three-fourths of their money. (Also Read What is the Best Way to Invest in Volatile Markets? )
Anyone investing in high risk options will demand a higher return as they also stand the chance to lose a lot. That is why stocks pay more as they are considered riskier than bonds. Also long term bonds tend to show more returns than short term bonds. The reason is that the longer you wait the higher are the chances that something might erode the value of that investment. (Also Read Should You Invest in Aggressive Stock Market Listed Companies? )
Short term stocks are influenced by a number of factors such as market trend, interest rate etc. however what matters in the end are the earnings growth.
In the past, particularly 1994 was the worst year for bonds. The intermediate-term Treasury securities fell to 1.8% but then in the following year it went as high as 14.4%. In the 1973-74 crash the Dow Jones average fell 44%. For the next three years it didn’t reach its old high. For the next ten years it remained below its ever recorded high. Will the US Economy Face Recession in 2011 Again?
Bond prices are sensitive to interest rate fluctuation. However, we have fixed interest rate bonds which don’t fluctuate with volatile interest rates. So a new investor will not go in for an existing bond because he knows that a new bond will pay more according to the newer and higher rate of interest. On the other hand when interest rates fall the bond prices go up. The ones to benefit the most are the bonds that have the longest maturity term. So long term bonds are affected more than short term bonds when the interest falls.
A stock market crash can send your stocks plummeting but good businesses bounce back after some time. But inflation steadily erodes away the value of your money without giving anything back. So be sure to invest your retirement money in something that guarantees the highest long term returns.
The bonds issued by the U.S. Treasury are the safest bet, which is reflective in their track record and also because the government can print more money to pay off the debt. So the interest rate of the Treasury is considered risk free and yields more than any other fixed rate investment. However on the flip side like any other investment the return on Treasury bonds suffers adversely by a rise in inflation rates.
Do not put all your eggs in one basket. Instead of concentrating on one investment medium, opt for a diversified portfolio. This way your investments don’t suffer too much by market ups and downs.
If you follow a theme, then you can opt for index funds as they offer diversification within a sector.
Diversification remains the key as picking individual stocks can prove jittery if the economy sees a double dip recession. Sound investors can select their own stock picks, but they should largely stick to large cap space and that too should have considerable exposure to defensive sectors such as pharmaceuticals and health care.
Investing in small cap stocks is not advisable as many of the large companies are available at cheap P/E valuations and these tend to attract more liquidity in uncertain times.
If you want to avoid the hassles involved in asset allocation and investment research then laying your investments in well diversified Mutual Funds is the best way to invest. You may even consider investing in Indexed Equities.