This blog post is for you if you who own a retirement account and have an investment horizon greater than 10 years.
There is some concern about US stock valuations being too high given the impact of the current pandemic on corporate profitability. In my view, long-term investors need not be concerned with this. As business activity likely begins recovery in 2021, I believe normal profitability and growth will resume.
What’s more relevant for long-term investors is their exposure to long-term bonds. The 10-year Treasury bond represents a loan to the Federal government and is considered “risk-free” by the market – in other words, you’re assured to get both your interest payments and principal back on time. What’s notable about this? In today’s environment, these popular US Treasury bonds promise to pay investors a whopping 0.58% per year for the next 10 years. And if you think that’s low, just wait.
The Federal Reserve, our central bank, has a mandate to keep prices stable in the US economy. To that end, they aim for 2% inflation per year. In other words, they want to ensure that the price of “stuff” rises by 2% per year. “So what?”, you ask.
The whole purpose of investing is to defer consumption now in order to be able to consume more later. For example, if you defer watching Netflix now and invest your money, you better be able to consume more Netflix later.
When factoring in the effects of inflation on returns, the annual 0.58% return offered by this “safe” investment turns into an annual loss of 1.39%. This means after 10 years of investing, your binge-watching ability on Netflix goes from 10 episodes to 9 episodes. Hardly a result worth waiting for!
So, what should be done about this?
Look at your own portfolio and see how much you hold in bonds. They likely take the form of bond mutual funds or sit inside your target-date retirement fund.
What kind of rates are these bonds paying you?
If you believe a change could make sense for you, consider talking to your 401k provider or an advisor about alternatives. You’ll be like the old rustic who once said, “All I want to know is where I’m going to die, so I’ll never go there.”
Want to learn more about how to gain peace of mind with your investments?
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Jonathan Bird, CFP®
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