There's stocks. There's bonds. And there's good ole cash.
But, do you really know the benefits and the pitfalls of these three basic investment types?
All three have a place in a well-diversified portfolio. The question is, how much of a place?
Turns out that amount is unique to each person's financial situation and tolerance for the up and down swings in the financial markets.
Technically speaking, this is what we call RISK.
Let's start with stocks:
WHY YOU NEED TO OWN STOCKS
You need to own stocks in order to keep up with, and outperform, inflation. Put it this way: if a loaf of bread costs $1 today and inflation is 5%, next year your loaf of bread will you cost $1.05! Your investments need to return more than 5% for you to get ahead, investment-wise. Over the long term, stocks can return 10-13% on an annualized basis. Stocks are also very liquid because they trade on an open market exchange. This means if you need your money tomorrow, you can get it quickly and close to market price.
Cons
Stocks can fluctuate a lot in price, which causes a lot of people anxiety. Choosing stocks that pay dividends can help minimize this problem. Clients also need to have a long-term 'time horizon' to reap the benefits of stocks.
WHY YOU NEED TO OWN BONDS
Bonds (Treasury) act as a portfolio cushion in volatile market environments. They help provide income to portfolios. On average bonds return about 4%, and most of that return is in the form of interest. When the bond matures you get the face value.
Cons
Bonds do not protect you against inflation risk. All you get is the interest payment and the value of the bond does not appreciate. Other than treasury notes and treasury bonds, most bonds are not very liquid in quantities that most clients can buy since, unlike stocks, bonds don't trade on an organized exchange. If you need to sell a bond before it matures, chances are high you'll suffer a big loss in principle.
WHY YOU NEED TO HAVE CASH
Cash is safe. You know that how much you have today is what you'll have tomorrow. It's great for emergencies. I always recommend that my clients have an emergency cash fund.
Cons
Cash goes nowhere! If your loaf of bread keeps going up each year, you will eventually run out of money.
CHECK OUT the chart below to view the historical returns for each of the above:
