Sometimes the best choice is to make none at all, particularly when all the options look risky. So if you’re deciding whether to invest in stocks, bonds or something else, remember that you could leave some of it in cash. So says Matt Freund, chief investment officer of USAA’s mutual funds.
As the Federal Reserve gets closer to raising interest rates, Freund expects price swings for stocks to get bigger. Bonds, too, are likely to get more volatile.
Instead of taking on a lot of extra risk for only a little bit more return, the right choice may be to get more conservative, says Freund, who manages several bond mutual funds. He recently talked about why it can make sense to stash some cash under the mattress.
Q:How much more volatility should we be expecting once the Fed begins raising rates?
A: We’ve already seen it. We saw it in August, when people were trying to make a huge news story about a 10 percent decline for stocks. I think it is going to get worse.
Q: Aren’t stocks supposed to do well, even after the Fed starts raising rates?
A: Everybody talks about how stocks typically don’t peak until two or three years after the Fed begins raising rates. Is that going to happen this time? Is it safe for stocks? Well, we’re not sure, but I suspect that it’s not.
Typically, when the Fed raises rates, the economy is accelerating. And at USAA, while we’re not calling for a recession, we’re not calling for an acceleration, either. We think we’re going to be seeing more of the same, where the economy is kind of grinding along at very modest growth.
Q: So stocks don’t look like the better investment versus bonds?
A: People always talk about how you need to buy stocks today because they’re a TINA — there is no alternative. And I completely disagree. Stocks may beat cash or bonds. But that doesn’t mean you’re being paid for the risk, and that doesn’t mean it’s appropriate for you and your time horizon.
Q: I assume the first choice is stocks, and the second is high-yield bonds.
A: The high-yield index is yielding close to 8 percent. After expenses, it’s close to 7. So then you have to worry about defaults and price swings. If you’re investing for three to five years, I think the ballpark is in the low 6 percent to high 6 percent for returns.
Q:And stocks don’t look good at all?
A: Let’s say that you are the perfect, rational investor who invests without any emotions. Or you’re going to program the computer to do it. If you told the computer, “My time horizon is five years or 10 years,” it would put you in stocks. It would put you in emerging markets. But if you said, “Look, I’m really a six-month investor,” the offered returns don’t compensate for the risk, and it would keep you out of those markets.
Q:But that advice wouldn’t have been any different 10 years ago, right?
A: Yeah, but people always seem to forget it. There’s nothing wrong with holding some cash. Imagine you were that lucky person who was sitting on a big stockpile of cash in August. Everyone is running for the door. You would have been very well rewarded for putting that money to work. But how do you get that dry powder? You have to pull back when the market feels good, and that’s a time like now.
