You Decide: How should you invest now?
The recession has devastated our wealth. Household wealth is off almost 20 percent from its pre-recessionary peak in 2007. No decrease in wealth in the last 50 years has even come close to this drop.
As their stock and home values fell, investors did the logical thing; they moved their remaining money to safety. Investments in government-insured CDs and super-safe federal bonds soared. However, the downside of these investments is that they paid very low interest rates. Yet investors accepted the trade-off of low rates for high safety because of their fear over the future of the economy.
Today, most economists think the financial panic we experienced a year ago is over, and while many issues still remain, the economy is beginning to recover. Investors, therefore, are becoming restless. Safety, while still important, is moving down the priority list, and earnings are moving up.
But with the economy still fragile and investment markets uncertain, where should investors consider putting their money? What are the pros and cons of moving investments away from safety? Specifically, what risks might investors face in trying to earn more on their money?
Let me answer this question by looking at three categories of investments – stocks, commodities and fixed-interest-rate investments. Stocks, of course, have had a wild ride the last two years. After falling by over 50 percent, to date the stock market has recovered about half its losses.
But some say the strong recovery in stocks is simply due to the economy moving from “code red” to “code orange.” That is, once it became clear the economy wasn’t going to fall off a cliff – go into a depression – stocks bounced back.
Now the relevant question is: where do stocks go from here? To answer this question, it’s important to understand that performance of the stock market is ultimately tied to performance of the economy. To be exact, the stock market thrives when the economy is expanding and inflation is held in check.
Unfortunately, there are questions about both future economic growth and future inflation. Most economists think that while the economy will grow, it will expand at very slow rates as households curtail their spending while they pay down on debt. There are also concerns that inflation won’t remain tame because of all the money the Federal Reserve has printed to fight the recession. So the future course of the stock market will likely be bumpy.
If future inflation is a worry, does this mean commodities are the place to invest your funds? By commodities, I mean basic inputs like metals, energy products and agricultural output. Gold and oil are often considered the major commodities.
Commodity prices surged in late 2007 and early 2008, plunged in late 2008, but then staged a partial rebound in 2009. Lately, they have been lagging again. So one lesson is that commodity prices are volatile; they can make quick turns both up and down.
One of the major arguments for investing in commodities now is the fear of future inflation. So far, however, there’s no evidence of an immediate inflationary problem. Also, Fed Chairman Bernanke has clearly stated he will pull back the extra cash he has created if he sees inflation headed higher. So the case for a commodity price push fueled by higher inflation is not guaranteed.
Finally, there are investments I’ll call fixed interest earning, such as CDs (certificates of deposit, not compact discs!) and corporate bonds as well as government bonds. These can be purchased individually or in mutual funds. These investments pay a fixed interest rate for a certain number of years. Usually, the interest rate is higher the longer the number of years. For example, today you can almost triple the interest rate earned by purchasing a five-year CD compared to a six-month CD.
But there are risks to chasing higher rates by “going long.” If future interest rates rise, what looks like a good long-term rate today may turn out to be a low rate tomorrow. Indeed, many economists think interest rates will have to rise eventually. One strategy would be to buy fixed-interest-rate investments of different maturities. Another is to invest in their variable-rate cousins – CDs or bonds where the interest rate changes with economic conditions.
I know what you’re thinking: I’ve raised more questions about investing than I’ve answered! Yes I have, and this is because the investment world is one of trade-offs and not sure things. I’m hopeful I’ve armed you with enough facts and ideas that you’ll be able to consider the right questions as you decide how to invest, which, in my mind, is half the battle! – Mike Walden
Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his /You Decide/ column every two weeks. Earlier /You Decide/ columns are at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm
Related audio files are at http://www.ncsu.edu/waldenradio/
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