What happens when I receive questions?
When a reader sends me questions asking for my thoughts via email or on the comments section of my blog, I do my best to provide timely feedback and my opinion. The post titled “Inflation Worries and Prudent Investing” (https://proverbs27flocks.com/2021/05/15/inflation-worries-and-prudent-investing/) generated a set of questions from a thoughtful reader. Here are the three questions (with minor editing changes):
“1) Based on your write-up, are you suggesting that if one has a 60/40 or 70/30 stocks & bonds mix, should he consider selling bonds due to anticipated inflationary environment?
2) What about REITs like VNQ and other stocks in these situations when inflation is going up?
3) Should I just sell all stocks, bonds & different sector ETFs and invest proceeds into FNDB, VYM & SCHD? Your thoughts please!”
First of all, the reader was asking good but complex questions when viewed as a unit. Therefore, a simple answer is not something that will address every nuance of every possible situation. However, here are my thoughts in general…
1. ALLOCATION: When the reader asked about 60/40 and 70/30, they were referring to common broker advice to keep a certain allocation in stocks and bonds. So, for example, 60/40 would mean that I invest 60% of my assets in stocks and 40% in “safe” investments like bonds. I do not subscribe to the 60/40 or 70/30 thinking. Our bond holdings and bond ETFs are less than 2% of our total investment mix. The reason? That it is short-term thinking meant to calm your nerves during market volatility or a bear market. While there is some income from bonds, and the income is fairly reliable, there is essentially zero growth. Therefore, any investor who thinks they (or their spouse, or dependents) will live at least ten more years should have a long-term perspective. Gradually moving to bonds is not a long-term strategy, in my opinion. I dislike Target Date mutual funds for the same reason. A target date fund automatically moves you into more bond holdings as you get closer to the target retirement date.
2. BONDS: I think bonds will fare very poorly in an inflationary environment. If the income someone can get from an FDIC insured savings account or CD purchased on the Fidelity Investments website approaches 3.0%, bonds will certainly be devalued, in my opinion. You will still get the income, but why settle for income and the almost certain depreciation of the asset?
3. REITs: In general, I like REITs (Real Estate Investment Trusts) and real estate investments. I like ETFs VNQ and FREL, but don’t own either one of them. I prefer to select the REITs I want to hold. Inflation tends to drive up the value of real estate. If it costs more to buy the “ingredients” to build a home, apartment, or warehouse (and many other real estate assets), then the value of existing properties (if the location factor and the asset usefulness and quality are solid) will likely increase in value as well. In addition, it is likely that rental income will increase on existing properties. This provides growth and the potential for significant upside to offset inflation. Consider MPW (Medical Properties Trust, Inc.) for example. The current yield is 5.33% and the stock has increased more than 80% in ten years. Do the math. You might get 5% from a bond but will the value of the bond increase 80% in ten years. Probably not.
4. FNDB, VYM, and SCHD are primary ETF stock-focused choices I would recommend to most investors. However, I think these are missing some important pieces of the market. For example, I think investors should consider allocations to small-cap (example: IJR) and mid-cap (IJH) investments. These can be great growth investments. The downside to IJR and IJH, for the income-focused investor, is that the yield is much lower.
5. PREFERRED STOCK: Don’t forget preferred stocks as an alternative to bonds. Some possibilities are: PFF, PFXF, and PFFD. Preferred stocks and bonds suffer from some of the same weaknesses, but I like the yield on preferred equities. I own shares of all three of these ETFs.
There are some investors who might benefit from a higher concentration of bonds in their retirement accounts. However, if your life expectancy is that you will live another ten years, be careful not to have too much devoted to bonds. Inflation will work against you.