A friend once told me you could fix anything with the right tool. Tom was a chain-smoking retired Air Force pilot frustrated with people who tried to fix everything with a screwdriver or a hammer. He often ranted that your project will turn out looking horrible if you don’t have the proper tools.
It’s true, the right tools help, and no one tool is better than the next. Each one has a unique purpose: a screwdriver or a hammer are each designed for something specific. My tool kit collection has grown over the years, adding to it as I worked on more construction projects. I now own several tools allowing me to tackle various projects.
Investors often look for the best single investment. They want to know what is working now. If stocks are good, bonds must be bad. However, it doesn’t work that way. Like tools, investments are designed for a specific purpose. Each one has pros and cons, but when used together, the pros outweigh the cons.
Stocks are best suited for long-term growth. If you buy stocks, you expect them to grow, and, hopefully, they’ll be worth more tomorrow than they are today. If you’re patient, they can increase your wealth over time and generate dividend income. They’re one of the best investments to own, but there is a dark side – stocks often fall significantly. Each year it’s not uncommon for stocks to lose 10% or more, and occasionally they can drop 40% to 50% as they did from 2000 to 2003, 2008, and 2020.
Bonds are safe, designed to generate income and preserve wealth, especially US Treasury bonds. Interest rates on bonds are currently low, so they’re not generating much income, but they still provide a level of protection not found in other investments. Also, treasury bonds are guaranteed. Bonds and stocks pair well together because they’re inversely related. Risks to bonds include inflation and rising interest rates. If rates rise, bonds fall. A 1% rise in interest rates will cause a 30-year bond to drop about 16%.
Cash is an investment, and it plays a vital part in portfolio construction. If you’re purchasing something today, you will likely use cash, not stocks or bonds. Cash is liquid. In addition to buying goods and services, it can be used as an opportunity fund, allowing your other assets to grow or generate income. If stocks fall, you can dip into your cash reserve to add to your holdings. Cash is an excellent short-term investment, but it will not keep pace with inflation.
Gold, silver, and other alternative investments on their own don’t do much. They don’t pay dividends, and historically their returns have been sub-par when compared to stocks, but if you fear a steep spike in inflation, then allocating a few dollars to this sector might work.
Investing in one asset class is speculation; investing in several is diversification and prudent. A portfolio of numerous asset classes will give you the best opportunity to make money. Rebalancing your portfolio at least once per year between stocks, bonds, and cash keeps your asset allocation and risk tolerance in check.
In addition to traditional assets like stocks, bonds, gold, and cash, you can add supporting tools like real estate, options, or crypto-currencies, depending on your risk tolerance.
Investments, like tools, are designed for a purpose, and they are unique to the owner. When you build your investment portfolio, make sure it fits your time horizon, goals, and personality.
Work whatever tools you may have at your command, and better tools will be found as you go along. ~ Napoleon Hill
July 7, 2021
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.