When you talk about investing for beginners you need to be very careful when you compare stock funds vs. bond funds because most beginners don’t know stock funds from bond funds. Come to think of it, most of the folks investing money with me when I was a financial planner didn’t understand their bond funds, especially. In 2014 and beyond, this could be costly.
Stock funds are a great way of investing for beginners who want to invest money in stocks. Most people get the concept and understand the risks involved. Bond funds are a different story. The majority of people investing money in them tend to view these funds as very investor-friendly. After all, over a recent 30-year period they outperformed stock (equity) funds. Not only that, but they seldom a bad year, while equity funds went through some very rough times.
Over the past year or so a handful of my readers have taken exception to my warnings about bond funds vs. stock funds for 2014, 2015 and beyond. Let me explain, and simplify investing for beginners, because this is a subject of importance to all investors. After all, you need to own both kinds of funds in order to have a balanced portfolio; and this should be one of every investor’s goals.
The issue of stock funds vs. bond funds is really a matter of risk vs. potential returns. People understand that the former can be risky, but they accept this because they know that they can also be very rewarding. For example, equity funds were sporting returns of about 30% in 2013. From their lows of 2009 they were up about 150%. Those kinds of returns are worth taking risk for. That’s investing for beginners 101. The higher the potential returns… the higher the risk.
On the other hand, few average investors today understand the risk vs. potential returns issue when applied to bond funds for 2014 and beyond. In fact, many have become attached to these funds. After all, they have been steady performers since the early 1980s, and have paid attractive income (dividends) vs. safe investments like bank CDs. At the same time, the share price (value) has increased. The problem is that most investors don’t understand the risk involved; and few understand WHY these funds have been such good investments.
What I emphasize in investing for beginners 101 is that there are few things you can count on in the world of investments. For example, you can safely bet that there will always be uncertainty. And there’s one more rule of thumb you can count on. When interest rates go down bond prices (and bond fund values) go up; and when interest rates go up they go down. When I was a financial planner I explained this to every client I sold these funds to. Rarely was it an issue, because interest rates peaked in 1981, and basically fell for over 30 years.
Today’s average investor has never experienced an extreme economic environment of rising interest rates. Rates soared to historically high levels in the late 1970s and early 1980s. Some investors were sitting on losses of almost 50% in their bond funds in 1981. These investments are not safe, and the issue in 2014 and beyond is the prospect of higher interest rates. With rates near record lows this means that you are accepting risk to get a dividend of about 3% a year in longer-term bond funds. Plus, the potential for rising share prices (value) is dismal, since interest rates can’t really go much lower.
Successful investing is always challenging, and investing for beginners can be spooky at times. I believe that 2014 and beyond could be a spooky time for investors. Our government has lowered interest rates to EXTREMELY low levels to stimulate the economy. Now the powers-that-be are trying to deal with unwinding the situation. Interest rates could climb more than expected.
In the stock funds vs. bond funds debate the primary issue I see is that the risk vs. potential returns is not favorable to bond funds because the potential returns are limited, much as they have been for the past few years. If the economy stalls and interest rates take off they can both be losers… both involve considerable risk in 2014 and beyond. Investing rule #1 for investing for beginners: when interest rates go up, bond prices and bond fund values go down.
Don’t despair, investing for beginners can be challenging. Keep this in mind: the risk vs. profit potential still makes investing money for higher returns the winner vs. safely squirreling it away and earning peanuts.