The Dow Jones industrial average’s 666-point plunch on Feb. 2, and its 363-point drop on Jan. 30, were sharp reminders that stocks are risky after their extraordinary gains of recent years, and bonds, the chief alternative to stocks, are shaky too, as rising interest rates are sure to push down prices. Though many experts say don’t worry, former Federal Reserve Chairman Alan Greenspan says that stocks and bonds are both in bubbles. So, with the two biggest asset classes looking hazardous, what’s the alternative? Experts cite a number of options for investors averse to risk, willing to play a more active role in managing their portfolios, pondering where to put new money, or eager to venture to the wild side with a little active trading – everything from building up cash reserves to buying real estate, energy funds, convertible bonds and preferred stocks. The goal is to find assets that are uncorrelated with bonds and stocks – ones that march to the beat of a different drummer. “While I don’t have clients, I give presentations and people are nervous,” says Robert Johnson, president of the American College of Financial Services in Bryn Mawr, Pennsylvania. “The problem is, many investors think they can time the market. Investors would be wise to adhere to the old Wall Street adage: “Time in the market is more important than timing the market.” That said, he believes bonds are even riskier than stocks, as rising yields on new bonds will make older, stingier bonds less attractive to investors. Long-term investors, Johnson says, will probably be better off sticking with stocks rather than shifting heavily into bonds. “I believe that long-term investors should be looking at dividend-paying stocks to hold over a long time horizon,” he says, recommending companies that have consistently raised dividends over the years. “I think they are a wonderful alternative to bonds.”
Nervous investors should also consider paying down debt, starting with high-rate loans like credit cards and moving on to the mortgage, especially if it has an adjustable rate that would rise as interest rates climb, he says. Cashing out investments to have something to show for recent gains with a home improvement, second home or new car is a “bad, bad, bad idea,” Johnson says. Cashing out to spend leaves a smaller base for future growth. “The best advice is that people should keep investing for their future whether the market has recently advanced, declined or stagnated,” Johnson says.
Other experts suggest a range or alternatives to bonds:
Cash. Bank savings and money market accounts won’t earn much but would hold their value as stocks and bonds fall, and be available for new investment when conditions look better.
“The most important lesson to learn from past volatile market cycles is that you do not have to take action every time there is a market pullback or rate hike,” says Jon Ulin, managing principal of Ulin & Co. Wealth Management in Boca Raton, Florida. “It is important to stay diversified. If you are nervous and feeling bearish, decrease your equity exposure and increase your allocation to cash.”
Convertible bonds. These are bonds that can be converted to stocks under given conditions. Richard Perkin, vice president for convertible income strategies at Wolverine Investments in Westport, Connecticut, says the convertible feature makes these bonds less likely to fall substantially as interest rates rise, while the bonds tend to rise in value alongside the company’s common stock.
“If the underlying company’s share price falls, investors can not only hold the bond and continue to receive coupon payments, but also be made whole again on their original investment upon the bond’s maturity,” Perkin says.
Rental property. Bobby Montagne, CEO of Walnut Street Finance, a private loan investment fund in Fairfax, Virginia, says, investment property “offers steady earnings, growth and income to hedge against inflation, since rents typically rise as time passes. That’s important to older investors who may spend 30 or even 40 years in retirement and need income that keeps pace with inflation.”
For those not inclined to buy property directly, he recommends professionally managed funds that lend to renovators who buy, fix up and resell properties. A fund spreads risk among many properties. “Private loan funds pay out monthly earnings, just as bonds do,” he says, noting that fund values do not fall like bonds as interest rates rise.
REITs. Real estate investment trusts are funds that own apartment buildings, self-storage units, strip malls and other types of real estate. Peter Sander, author or “The 100 Best Stocks to Buy in 2018,” says good REITs pay healthy dividends while share prices go up with rising values of properties they own, but he urges investors to shop carefully.
“My current thinking is that REITs – ones that are good businesses, not just real estate portfolios – will do well because they pay high yields, are growing businesses, and raise their dividends,” he says.
Other options. Ulin suggests investors also look at lesser-known assets that tend to move independently of stocks and bonds, like master limited partnerships, which are funds that own energy infrastructure, such as pipelines. Also, emerging market bonds are an option driven by forces different from those governing U.S. bonds.
But long-term investors will probably do best by accepting that ups and downs are just part of the game, Ulin says.