Is there really such a thing as safe investing?
After all, municipalities can default on their bonds, companies can cut their dividends and a market meltdown can wipe out even the most foolproof investment strategy. Let's face it: Even buy-and-hold investors lost money over the last decade simply by leaving their portfolios alone.
Yet even if the market holds up and nothing catastrophic happens, a "safe" investing strategy can still lose money. For example, a money market fund yielding an annual interest rate of 1 percent erodes by 2 percent a year if inflation rises by 3 percent a year or more.
Ironically, the safest investment strategy is one that incorporates a certain amount of risk, not one that avoids risk altogether. Let's say, for example, that you assemble a portfolio that consists of one-third stocks or equities-based mutual funds and two-third bonds and cash. This way, you get the safety and cash flow you need from your fixed-income portfolio and don't have to worry if the stock market takes a short-term hit. If your stocks do well, you can always take some money off the table at the end of the year and "rebalance" your portfolio so that you continue to maintain a 2:1 ratio between your stocks and bonds.
Unfortunately, that takes discipline--the kind that few investors can maintain for any lengthy period of time. After all, who wants to sell a stock that's doing well and invest the cash in safe, boring bonds when the gambler inside of us says to double down and take a shot at getting rich?
But what about the "market-neutral" funds that are being touted by Wall Street as a safe way to play the market whether stocks go up or down? I'd be careful about diving into these. While the concept makes sense (the fund manager buys stocks that he thinks are strong while selling or "shorting" an equal amount of stocks that he thinks are weak), fees are high and execution can be spotty. According to CBS MarketWatch, some market-neutral funds lost more than 30 percent to 40 percent in 2009 with a handful returning 7 percent to 10 percent before fees. What's more, the fund manager's need to constantly rebalance his portfolio may generate capital gains that will reduce your shares' after-tax appreciation.
Think of it this way: Like a diet, the safest investment strategy is one that you can stick to in good times and bad. Yo-yo dieters and investors rarely lose weight or make money.