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You don’t need to listen to Warren Buffett (if you’ve allocated your investment portfolio properly)

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Warren Buffett came out and highlighted the risk in bonds recently. He pointed out that long-term, stocks have a lot less risk than currency-based investments like bonds.

Stocks or bonds? Maybe both

Backing Buffett, the S&P 500 has had it’s best February since 1998. The S&P/TSX 60 has hit a five-month high.

Sadly, RRSP contributions are hitting lows just as the markets have taken off.

There are many reasons RRSP participation has declined: difficult economic times, fear generated by stock market volatility and the effect of demographics are just a few.

If some investors are avoiding the stock market because of fear stemming from the financial crisis, it’s cost them this year. If this becomes a long-term trend, it will cost people in retirement.

In “Bonds: Why you should love the unloved investment”, I discussed the role bonds play in a diversified, balanced portfolio within the context of stock market corrections.

Since the financial crisis, investors have seen a bull market in bonds as people bought “safer” investments like bonds.

But bonds tend to rise when interest rates decline. If interest rates don’t continue to decline, the return on bonds will be limited.

Considering today’s already low rates, is it likely that they’ll continue to decline?

If interest rates go up, the returns will become negative, and we might see the first correction in the bond markets since before the financial crisis.

Bonds vs. the S&P/TSX 60: The return of equities

Dom Grestoni of Investors Group recently said: “Rates are going to start rising, so if you commit to a 20-year bond at 2½% and the market rate goes up half a percentage point, you’re going to part with 30% of your capital.

We’re seeing valuations that are now discounted relative to the past 20 years, and interest rates are at record lows … Would you rather lock into a 10-year government of Canada bond paying 2.1%, with no prospect of growth, or buy a high-grade dividend-oriented stock, like a bank or utility, with yields above 4% … and that dividend is going to grow year after year.

Investors were underweight bonds as stock markets went from outperforming to underperforming during the financial crisis. Many may now be overweight bonds.

Both Buffett and Grestoni are trying to alert investors to this danger.

The mania is the message

Buffett would probably be happy if you didn’t need to listen to him. Some wise investors are already well-prepared.

How can you be one of them?

What Buffett was trying to counter are the manias that investors inevitably fall for. Sadly, most investors go for whatever investment vehicle has been getting the majority of cash flows.

Too many investors arrive late in the game.

Bad news burnout

The barrage of bad news has influenced investors: events in Europe, and other withering news grabbed all the headlines. Have people noticed that news has gotten more positive regarding companies, Europe and the outlook for stocks?

There are still threats amongst the opportunities. Financial news from Europe and the U.S. is mixed though better than it was.

Bonds?

There’s nothing wrong with holding bonds in a properly diversified portfolio. In fact, many managers hold bonds in their portfolios.

As mentioned in “Bonds: Why you should love the unloved investment”, many pundits were calling for a bond correction last year, and it turned out to be a great year to hold bonds.

But the same may not hold true in the future.

In Part Two, I’m going to discuss why having a plan benefits you when it comes to asset allocation within your portfolio.

Chart source: Globe Investor
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