When we plan our retirement portfolios, we are often pushed into a narrow group of asset classes — typically limited to domestic stocks and bonds. While these assets have generally performed well over the long-term, they are also vulnerable to downside risks. Furthermore, by limiting our exposure, we lose sight of other opportunities out there.
For retirement portfolios, it is especially easy to overlook these more esoteric asset classes because we want our retirement portfolios to be “safe,” and “safe” is often equated with “familiar.” But this can be dangerous. Bond yields, especially in the developed works, sit at record low levels. Furthermore, because returns on bonds are so low stocks have looked more attractive by comparison. Given that American companies tend to pay stable or regularly rising dividends (as opposed to foreign companies that typically pay out a percentage of profits), stocks have become bond proxies.
But what happens if interest rates rise? For those investors who have planned their portfolios using the limiting approach discussed above, this could be devastating. It follows that investors need to look for alternatives in order to mitigate this risk, or even avoid it altogether. I list three below.
Cash is the least sexy asset out there. Nobody wants to hold cash because it doesn’t yield anything and because “risk assets,” such as stocks and high yield bonds, are rising. But cash gives you options. If you have cash and a market opportunity arises, then you can take advantage of it. Even in a rising market chances are that over the next several months, one or two stocks that you really like will come down considerably in value. Even if you think they are good values now, the market acts in mysterious ways, and rather trying to time it or figure it out your best bet is to be prepared for as many eventualities as possible. Cash gives you this flexibility, and the opportunity to take advantage of mysterious and aberrant market behavior.