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Should You Pull Out of Stocks and Invest in Bonds?

Seth Jentner08/15/2012

Statistics show that many retirement savers yanked some or all of their money out of stocks and put it into government bonds or bank deposits. Is this really wise?

Investors who are shunning stocks could be sitting on a fixed-income powder keg.

Even though bond investors have been rewarded with capital gains over the last two years as interest rates declined and bond demand held steady, they are now in a potentially dangerous position, in my opinion. Through their effort to flee volatile stock markets, investors in high-quality, low-coupon bonds sit on a significant risk, if we face inflation and rising interest rates.

I’ve been asked:  “Aren’t bond investments safer than stocks?”

The simple answer is, “No.” Stock market volatility can threaten a portfolio but so can inflation, and too many investors are ignoring this. The Federal Reserve has said it wants to see more inflation. The Wall Street Journal notes, “Central bankers who wish for more inflation usually get their wish, and the result is rarely benign.”

Even at today’s 2% inflation, money is under attack. $1,000 today will be worth just $817 in 10 years. At 6% inflation, it will go to $539. This is what I call “safely going broke.”

Low interest-rate bonds will be big losers in an inflationary environment. Stockholders, especially those who own dividend-paying stocks, have a much better chance of staying ahead of inflation.

Most investors would be wise to invest into a portfolio of stock, bond and cash investments. And I personally would recommend investing in stock and bond index funds, which are invested in hundreds of companies, so the risk of permanently losing the value of your investments is relatively low.

By investing in both stocks and bonds, you stand a better chance of remaining fully invested throughout the inevitable market swings. By staying invested, you will avoid the potentially harmful results of marketing timing.

Finally, by rebalancing your portfolio periodically to maintain your desired stock and bond percentages, you will actually take advantage of market volatility without making futile market predictions.

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