Article Archive

No Perfect Solution

Finance

Issue: September 2009

By: Jerry Mosher, CFP

Last year, if you were sitting in U. S. Treasury investments while the market was declining, it seemed like you had found the perfect solution. Unfortunately, few people were in this position given the market had risen for five straight years and they at some point wanted the higher return that the market was providing. As the market continued its relentless decline in 2008 and the beginning of 2009, many people rushed to buy Treasuries, causing the Treasury yield to drop significantly. There was even a point where investors were buying the Treasuries knowing they would lose money during the period they owned them, but the safety of Treasuries - government-backed bills, notes and bonds - were the remedies of choice at that time.

In case your memory might be a little fuzzy, let’s review a few distinctions about Treasuries. A Treasury bill is a debt instrument that matures in one, three and six month time frames. Treasury notes are sold in maturities of one, two, three, five and ten year time frames. There is also the Treasury bond, which has a maturity of 30 years. There isn’t thought to be any credit risk to Treasuries given it is the U.S. Government that guarantees the return of your money. Today, there isn’t much return associated with that guarantee. The bills, as of the composition of this article, are paying approximately 0.3%, the 10 year note is yielding approximately 3.5% and the 30 year bond recently yielded 4.4%.

There isn’t any risk of loss with these instruments if you hold them to maturity, but there is a risk of your purchasing power being eroded by inflation. There is also the potential for loss if you are forced to sell the Treasuries before they mature. If interest rates have risen, the value of your bond will have dropped prior to maturity and your premature sale could generate an unanticipated loss. This latter risk is why longer maturity Treasuries must provide you with a higher yield to entice you to tie your money up for a longer period of time, thereby extending the period in which a premature sale could generate a loss. Given that interest rates are at an historical low and that the government has infused a large amount of money into the economy, it would seem that the risk of a rise in interest rates, at some point, would be a high-probability event. Unfortunately, Treasuries don’t appear to offer a perfect investment solution.

We are painfully aware that stocks do not offer a perfect solution after last year’s retreat, the largest in most of our lifetimes. At current prices, however, there are some stocks that are offering dividends that provide a greater yield than Treasuries. A significant decline in value increases the effective yield of the stock dividend, producing this phenomenon. If we find ourselves in an inflationary environment, history tells us that there has generally been a smaller negative effect on stocks than there has been on bonds. The future of stocks is also a function of whether we have experienced the low, whether the economy is recovering and whether each company can weather the storms and begin to again increase profitability.

We have experienced the risks that can occur with real estate. It was just a few years ago that I heard the often-quoted phrase, “You can’t lose in real estate.”

I guess the learning from all of this is that there is no perfect solution, and we are ultimately forced to compromise on what risks we are willing to assume. There isn’t any option to not accept some risk. The key is selecting the risks you can live with over a variety of economic conditions.

Jerry Mosher, CFP® is a 30 year veteran of the financial planning industry and is president of Mosher & Ellis Financial Planning in Lafayette, California. He has been selected three times as one of the 150 best financial advisers for doctors by Medical Economics. Jerry may be reached at (925) 284-9470. Securities offered through AMERICAN INVESTORS COMPANY Member NASD/SIPC.

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