Got money in a long-term bond fund or a 5-year CD? If so, you and I have different views of where the U.S. economy is heading.
In the post 3 Places to Put Money Now, I suggested stocks and real estate as appropriate investments for an economy that’s starting to emerge from the woods. The third suggestion — paying off debt — is always a great idea.
Now it’s time to see what investments you might want to stay away from.
Note, however, that behind these ideas is my belief that the economy is getting better: if you don’t agree and think that it’s getting worse, this is advice you’ll want to ignore.
Investment to Avoid: Long-term bonds
In the video new story above, I attempted to illustrate how bonds move in relation to long term interest rates by using a seesaw. On one end you have interest rates, on the other bond prices. So when interest rates go up, bond prices go down, and vice-versa. The longer the term of the bonds – that is, the longer it will be until the bonds mature – the more pronounced the swings.
If the economy is truly picking up steam, then the path of least resistance for interest rates is up. That’s why I’m counseling to avoid long-term bonds and long-term bond mutual funds: because if interest rates go up, bonds could get hammered.
Interest rates are at their lowest levels since the 1950s. Investors who grasp for that last percentage point of yield and buy long-term bonds are making a gigantic bet that rates will fall even further or at least hold even. Anything else will expose them to serious losses, as happened in the late 1970s. Long-term rates spiked past 13% by 1980, halving the value of some supposedly conservative bond portfolios.
So if you have a long-term bond mutual fund through your 401(k) or elsewhere, be aware of rising interest rates. I’m not suggesting that rates will rise suddenly or severely. Major interest rate increases are still months – if not years – away. Nor am I suggesting that you shouldn’t ever own bond funds: they can be appropriate for part of a conservative investment mix. But bonds are investments that shine in falling rate environments: That’s probably behind us.
Investment to Avoid: Long term Certificates of Deposit
You avoid bonds when interest rates are rising because they can fall in value. You avoid long-term CDs because of opportunity cost.
If rates do begin to rise, the last thing you want is have all your money locked up in a long-term certificate of deposit that doesn’t allow you to take advantage of higher yields. The time to lock in interest rates is when they’re peaking and expected to fall, not when they’re at historic lows and expected to rise.
That being said, there’s nothing wrong with spreading your savings around in various maturities, like money market accounts, short-term, and longer-term CDs. Then you’re prepared no matter what happens to rates. If they rise, your money market immediately pays more. If they fall, you’ve got a higher rate locked in with long-term CDs.
Investment to Avoid: Gold
In a recent article called Gold is a bubble – resist its charms, CNN/Money makes the case that gold is over-priced and due for a fall. Gold has nearly tripled over the last five years – this is a party that could soon be winding down.
From that article…
“When the economy moves from recession to prosperity, there will be little reason to own gold,” says Mark T. Williams, who teaches risk management at Boston University. “And speculators will learn the hard way that gold in times of financial stability is hazardous to investor health.”
As I suggested in the video above, behind the speculative fever that’s driven gold to historic highs is a fear of runaway inflation, global economic Armageddon and other nightmare scenarios. As an improving world economy helps dissolve some of these fears, the need to own gold will decrease, and perhaps, so will prices.
I own some gold in my portfolio, and will probably continue to, at least for the near future. But gold is in a bubble: sooner or later the music will stop – don’t be the last one standing.