The Pros and Cons in Gold, Bonds and Mutual Funds in the last half of 2013.

With the uncertainty in the economy in US, Europe and other parts of the world it’s hard to decide how to grow and protect your investments and your current and future lifestyle. You need to balance your needs, goals and your micro-economic situation with the macro-economic realities of the world. Below are pros and cons of the three main investment categories for small to medium sized investors in 2013.

Bonds as an Investment

Bonds have traditionally be a good safe haven type of investment. Many have used them for years as a tactic to move investments from the market to bonds to weather a short term storm or a period of excessive macro-economic risk. When the corner turned then moved a large percentage of the portfolio back into equities (stocks or mutual funds). BUT…. As of 5/29/12 mortgage rates dropped from 3.93% to 3.91% which is the lowest rate in history.

So? The “so” is huge and bad if you own low risk bonds in 2012.

Why? The price of bonds has a direct inverse relationship with interest rates. When the interest rates go down then the price of bonds go up.  Conversely, when the interest rates go up then the price of bonds go down. If the interest rates are at an all time low and are pushing towards zero percent, then it makes sense that the only way the price of bonds can theoretically only go is down. Only going down is a lousy investment.

Higher risk bonds, bonds from shaky countries, bonds from high risk municipalities and junk bonds have more micro-economic variables. They still have an inverse relationship to interest rates but the other factors like solvency and the likelihood of the bond holders to be paid back are sometimes bigger factors. Bond holders in some of the US car manufactures lost most or all of their investments when the US Government bailed them out. For example, 10 year bond rates for Spain rose to premium if over 6.5% on 5/28/12 due to further worries after the bailouts of Portugal, Ireland and Greece.

Housing is weak and unemployment for the long term unemployed is about to start ending. Even with Congress’ extension, the extended benefits will begin to end for thousands each week. Since only the people on unemployment are counted as unemployed, the data in the next few months will be highly misleading. The unemployment numbers may be slightly better (it is an election year) but the result may be a further housing and interest rate softening at best and another major foreclosure spike at worst.

Gold as an Investment

To be clear, I recognize that people who have bet the ranch on gold have done well on paper over the past few years. Why has it done well in my opinion?

• People are mad and scared of the political direction of the US.
• People are worried about the US debt and we are printing money without remorse which may lead to inflation, or worse, a collapse like in Greece.
• People are worried about Europe’s troubles dragging down our economy.
• The productivity output index of the US worker may be maxed out with the downsizings and may be declining.
• People want safe haven investments. The gold marketers always say, “Gold has never been worth zero.”
• There seem to be as many questions as answers to the future of the US economy and the world economy.
• Many more issues and reasons to buy gold or gold contracts.

The main concern is unsophisticated investors seem to tend to forget that gold does two things and two things only. It goes up and it goes down. Right now it’s up. Will it go up again: Yes. Will it go down again: Yes. My point is that putting most of your retirement dollars into one investment is highly risky. My worry is some unsophisticated investors have drunken the gold marketers Kool-Aid and think gold is invincible. My fear is when gold crashes, like most crashes, it will crash fast. The answer is smart diversification and a balanced portfolio. Do you take your profits now or keep riding the train? I don’t have that answer. I’m just saying be careful.

Mutual Funds

Like any one shot undiversified investment, individual stocks can be similar in risk to gold. The small to medium sized investor can spread risk by investing into mutual funds. In my opinion, the fund managers have too much advantage over the small investor on a day in and day out basis for many reasons. Mainly they have better access to more information faster. They can stay minutes or hours ahead of the small investor more often than not if they are good. If they are not good, the mutual fund company management will most likely replace a bad fund manager and the company will eventually find someone who is good which is bad for you.

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So, how does the Small to Medium Sized Investor Win?

A winning strategy for me is to try to predict macro-economic trends either in an industry, segment or region of the world. Let the fund manager ferret out the details, law suits, production delays and rumors of the individual companies and other information you do not have access to. You can look at funds that focus on what you think will be growth area in the future. For example, if you see Europe in collapse but you see US small caps growing or Pacific Rim companies reacting fast and growing to quickly take advantage of change. Thus, you would consider finding a good fund or two that focus on Pacific Rim.

In Conclusion

You still need to go old school and have a balanced portfolio to get the biggest return with the most reasonable risk. To me, low risk bonds have little upside unless you subscribe to the thinking that no growth is better than a loss. The bad news is bonds can only go down. Gold and other precious metals are fine and have been fantastic but too high or a percentage of your portfolio could make your risk exceed your upside or exceeds your probable reward “which is illogical” to quote Mr. Spock. Mutual Funds are a good solution if you find the right ones for a balance portfolio. Be smart and good investing.

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