When “Safe” Means “Risky”

10/13/2010 1:00 pm EST

Focus: MARKETS

Michael Brush

Columnist, MSN Money

Michael Brush of MSN Money says investors may be making a big mistake by avoiding stocks and pouring their money into gold, bonds, and low-yielding savings accounts.

What if putting cash into today's popular "safe" investments was actually a risky move?

Regrettably, that just might be the case. Instead of stocks, investors are piling their savings into:

  • Bonds, which by many accounts are in a bubble.
  • Savings accounts that pay interest rates below the 0.9% core inflation rate—a rate that will rise if the economy picks up (and it will).
  • Hard assets, such as gold—which has been setting price records lately, just as it did during the economic crunch of the late 1970s, before prices fell and stayed down for more than 20 years.

The bottom line: In this environment, saving money instead of putting it to work can hurt you.

Mind you, it's hard to fault people for socking away cash. The recession rattled our portfolios. And the stock market has been flat for a decade, with a lot of risk for no return.

The personal savings rate—defined as after-tax income minus consumption—has been above 5% since November 2008, a level not seen since August 1998 (except for one month).

A big piece of this comes from people simply paying down debts, not necessarily stashing away more cash. But people are plowing extra money into savings accounts, bonds, and gold, and leaving stocks.

If the past is any guide, many Americans will be in savings mode for years, according to analysts at Barclays. The net result is the much-talked-about "new normal," a phrase used to describe a psychological shift toward savings.

You might ask: What's wrong with that? After all, too many people spent too much in the bubble years and put away too little.

The risk is in going too far the other way: You need to invest, not just save.

Yes, bonds and gold can be a solid part of an investment portfolio. But if bonds are in a bubble or gold prices tumble, it could be years before their time comes around again. And right now, they look like tech stocks did in early 2000.

James Paulsen, the chief investment officer of Wells Capital Management, applies a simple but effective stock market valuation tool known as the rule of 20. According to this rule, the natural value for Standard & Poor’s 500 stocks is a price-earnings ratio equal to 20x, minus the inflation rate.

This rule was developed in the 1970s, but it would have correctly guided us to where S&P 500 stocks actually have traded since the 1950s.

Right now, the rule of 20 is flashing a Buy for stocks. With inflation around 1%, [it says] S&P 500 stocks should trade at 19x earnings, well above the current level of 14x earnings. That suggests the S&P 500 should be at 1,550, about 35% above current levels.

If the signal is right, investors are making a mistake by staying out of stocks.

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