Stocks are now officially virtually “the only game in town.” As of Thursday’s announcement by the US Federal Reserve, their benchmark interest rate will remain at near-zero for the foreseeable future. The “foreseeable future” has been indicated as at least 2022 and perhaps beyond. The “benchmark interest rate” set by the Fed dictates interest rates on most money markets, bonds, and CDs – and most mortgages. This discussion is focused on bonds, CDs, and money markets versus stocks.
If US Treasury bonds, bank CDs and other high-quality, low-risk debt and money market instruments continue to offer near-zero yield, then the choice between stocks and bonds becomes clear: at least go for the dividend yield (and potential growth) of stocks! Right? This conclusion by apparently hordes of investors is mostly why stocks have risen markedly from May through August following the major, major downturn back in late March and April of this year.
BUT the situation is not that simple because stocks contain risk (far more risk than government debt and CDs) and must be judiciously watched and managed. This balancing act plays into to the concept of “Asset Allocation” which is defined as setting a pre-established percentage mix of stocks vs. bonds vs. cash (plus vs. other asset classes such as real estate). Prudent, long-term oriented portfolios are designed around Asset Allocation.
In this environment where “stocks are virtually the only game in town” for investors looking for return, rebalancing is a MUST. Rebalancing means periodically bringing a portfolio back to a pre-established percentage mix of stocks-bonds-cash (plus perhaps other).
When to rebalance? The schedule can vary by preference and tax or cost-sensitivity. (Please ask me more about this.) When the percentage of stocks in a portfolio rises disproportionately – or any asset class rises disproportionately (including company stock, a personally-owned business or real estate) – steps can be taken to take profit off the table or diversify somehow to bring the percentage of that asset back into “balance.” The reverse takes place on the downside. The timing of rebalancing is not perfect and contains risk although one to two times per year on a predetermined schedule can be a disciplined approach.
Bottom line, NO ONE, even the US Fed, knows for sure what will happen in 2021 and 2022 but indications are that the US (and world) economy will not risk overheating in that time frame. The US Fed has stated its assessment. And while the Fed has created an environment where stocks seem to be “the only game in town” rebalancing and paying attention have never been more important.