Q: Where would you invest now for the highest return?
A: If ever there was an environment that cried out for a diversified portfolio, it's this one--not because there are so many good options, but because all the investment possibilities right now seem somewhat flawed. Still, it's a good time to review the basic components of a varied portfolio (i.e., stocks, bonds, and cash) and the pros and cons of each.
Pros: Historically, stocks have been the source of the highest returns of these three asset classes, and offer some element of inflation protection. According to Standard & Poor's, the earnings yield (which implies the long-term return on investment at current price and earning levels) on U.S. stocks is about 8.1 percent--not bad, considering today's low interest rate environment.
Cons: Stocks have had a bumpy ride over the past dozen years, and haven't made any progress overall in that time. So if you invest in stocks, you have to accept the possibility of losses, and of waiting a long time before you get a decent return.
Pros: High-quality bonds offer guaranteed long-term returns, and intermediate-to-longer-term bonds are yielding more than you can get from savings accounts.
Cons: Prices can go down if interest rates rise, and that's a scary proposition at today's low yields. This leaves you vulnerable not only to rising interest rates, but also to rising inflation.
Pros: FDIC insurance on CDs, savings accounts, and money market accounts.
Cons: According to the FDIC, average rates on savings and money market accounts are below 0.2 percent, and even long-term CDs are below 1.5 percent. However, you can do better if you shop around.
There are no easy answers in this challenging investment environment, but the more you can keep a long-term focus, the better your chances of success will be.
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