Rational Investing: Stocks, bonds shouldn't be an either/or proposition

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Clark Davis is a 34-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money-management company.|ret||ret||tab|

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(In my last column, in spite of what I thought was a persuasive discussion on why he was operating out of fear rather than reason, we left Jimmy the Oracle convinced that he should sell his stocks and buy CDs and bonds. We continue.)|ret||ret||tab|

After talking about the issues of marketability and rates, Jimmy decided he would use only bonds in his portfolio, but he refused to consider any common or preferred stock. |ret||ret||tab|

"Haven't you seen the figures," he asked, "on the dollars that have been coming out of stock mutual funds and going into bond funds? It's in all the papers."|ret||ret||tab|

"Sure, I have. That's another reason to consider not buying bonds," I said.|ret||ret||tab|

Jimmy sighed; "It seems that if that's what everyone is doing, there's not much hope for stocks."|ret||ret||tab|

"Jimmy, one question if everyone is right, if everyone is doing the same thing, why isn't everyone rich?"|ret||ret||tab|

"Well, people you have who owned bonds have done a lot better than people who bought stocks, haven't they?"|ret||ret||tab|

I started to comment, but he was on a roll.|ret||ret||tab|

"So that's what I am going to do," he said emphatically.|ret||ret||tab|

There are no brick walls more impenetrable than Jimmy's mind when it is made up, but I kept trying anyway.|ret||ret||tab|

"It doesn't have to be shouldn't be a choice between stocks and bonds, Jimmy. Most portfolios should contain both. We've talked about that before in terms of asset allocation. But let's say you have to choose between the two, putting all your assets in either stocks or bonds. The time to buy bonds is when interest rates are beginning, or are in, a downward trend, not when they are at historic lows."|ret||ret||tab|

Jimmy pounced, "Are you saying that interest rates are going up?"|ret||ret||tab|

"No, not until the economy shows signs of accelerated growth, and that is certainly not the case now. But I would submit that the historic relationship between interest rates and inflation says that there's little room for rates to go lower."|ret||ret||tab|

He squinted his eyes, cocked his head to one side, and asked, "But don't you own bonds for your clients?"|ret||ret||tab|

"Sure, as part of diversifying their portfolios, but we use a laddered maturity approach and are scaling back significantly on the longer maturities. We are taking our gains there and lowering the time factor risk."|ret||ret||tab|

"Yeah, just when everyone else is buying."|ret||ret||tab|

"You're right, just when, as you said, everyone else is buying."|ret||ret||tab|

"So what are you doing with the money when you sell the bonds?"|ret||ret||tab|

"Placing it where the yield is comparable on a current basis, but likely to grow significantly over the next several years," I replied.|ret||ret||tab|

"Such as.?"|ret||ret||tab|

"I'll tell you in a minute but, since we are comparing it to a bond, assume that the bond will be held to maturity. Right now the rate of the 10-year treasury is just under 3.6 percent. That means if you hold it until maturity 10 years from now, you will collect 3.6 percent annually. The alternative we would use currently has a dividend yield of slightly more than 3.6 percent and "|ret||ret||tab|

JTO interrupted, "So? The bond is guaranteed and the stock isn't."|ret||ret||tab|

"You're right, Jimmy, the stock isn't guaranteed, but let's look at the guarantee on the bond. You are guaranteed that you will get your principal back not a penny more and that you also won't get one penny more each year than 3.6 percent during the 10 years. Granted, you're not guaranteed the dividend on the stock, but the company not only paid it every year since 1986, they have raised it consistently. We expect that they will continue raising it, somewhere in the range of 10 percent to 12 percent annually."|ret||ret||tab|

Jimmy mumbled something about what if the stock went down in value.|ret||ret||tab|

"No promises, Jimmy, but one financial fact you can hang your hat on is this: Any asset that increases the owner's income regularly will, over time, go up in value." |ret||ret||tab|

"OK, I'm still calling my broker and buying some bonds, but maybe I'll think about some stocks," he turned as he headed toward the door, "Oh, by the way, what was that stock?"|ret||ret||tab|

"Washington Mutual. Why don't you let me know what you think."|ret||ret||tab|

I haven't heard from him since. My guess is that The Oracle won't be back for a while unless the price of the stock goes down. Then he can say he told me so.|ret||ret||tab|

(Note: In the interest of full disclosure, clients and principals of Saint Louis Investment Advisors may hold positions in this issue.) |ret||ret||tab|

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