Investing for 70s-style pain
Inflation fears. Slowing growth. Budget deficits. If that's got you thinking portfolio overhaul, think again.
By Walter Updegrave, MONEY Magazine senior editor

NEW YORK (MONEY) -- QUESTION: Several business publications have pointed out that the economic and investing climate of today an eerie resemblance to that of the early 1970s. There are large government deficits due in part to an unpopular war, inflation beginning to rise and a timid Fed response. Today, we've also got the looming retirement of the boomers, which wasn't a factor in the 1970s. Assuming the U.S. economy is in for some rough sledding during the next decade how would your investment approach change? --Bob W., Saint John, Indiana

I don't agree that today's financial landscape really has all that much in common with "That '70's Show" economy and markets of more than 30 years ago. True, inflation has picked up a bit of late, but I think the economy overall is more flexible and resilient and more attuned to the dangers of inflation.

I also wouldn't call the Fed's response timid. Overall, I think Fed chief Bernanke and his merry band of monetary policy makers are doing a pretty decent job of demonstrating they're willing to nudge up short-term interest rates to keep rising prices under control while also trying to avoid tipping us into a recession. Of course, monetary policy is as much art as science, and they could get this balancing act wrong.

But at this point, I think we're as likely to see a return to the stagflation of the '70s as we are to see a revival of leisure suits and hot pants.

But let's just say for argument's sake that I did think we were on the verge of a reprise of the early '70s. What would I do?

  • Well, I'd get out of stocks, since they got hammered in the 1973-74 bear market and actually posted a negative 2.4 percent annualized return in the first half of the decade.
  • I'd hunker down in intermediate-term bonds, which actually did pretty well the first half of the '70s.
  • And I'd look to hard assets like real estate, gold and commodities, which tend to do well in periods of rising inflation.
  • Finally, as I was sitting in these assets, I would be watching rising long-term interest rates to try to figure out when they were ready to peak, as they did at 15 percent in 1981. At the point I thought they'd hit their zenith, I would stash my money in long-term zero-coupon Treasury bonds and ride them to huge capital gains.
Back to reality

The problem with the pleasant little daydream I just went through is that I don't know what lays ahead any more than investors celebrating the New Year on Jan. 1, 1970 did.

I could try to figure out what I think is likely to happen. But the more I tailor my strategy to a specific scenario, the more risk I take.

Because if that scenario doesn't pan out, my portfolio might not be positioned well to take advantage of the way things actually do unfold.

I can always revise my strategy. But I may have to sell positions at a loss, incur trading costs and then find myself right back where I was before.

So my answer to your question is that my approach doesn't change all that much with changes in the economic outlook. And I don't think yours should either. Instead, I think it makes sense to create a diversified portfolio that covers all the bases and makes sense given the length of time you intend to have your money invested. And then, except for rebalancing this portfolio about once a year or so, I think you should pretty much leave it alone.

Portfolio for all economies

What might such a portfolio look like?

Well, assuming you're investing for the long-term - say, 10 or more years - it would have a substantial position in stocks or stock funds at its core. Large-company stocks, shares of small firms, growth-oriented stocks, value shares, and some foreign issues thrown in as well.

As for bonds, I'd probably stick more to the short- to intermediate-term (funds with an average maturity of, say, seven or fewer years), but I could see putting a small portion of my bond stake in high-yield shares for a bit more return, not to mention adding a dollop of TIPS, or Treasury Inflation-protected securities in case inflation does act up again.

I could even see expanding my investment horizons farther for additional diversification, perhaps having a bit invested in REITs, real-estate related funds or maybe even funds that invest in commodities or precious metals. But we're talking about minor positions here around core stock and bond holdings, not taking a flier on any of these specialized investments because you think they're poised for big gains.

And, as I mentioned, a key to this strategy is periodically rebalancing your holdings, say, once a year, to bring your portfolio back to its original proportions. This strategy has two beneficial effects. First, it prevents your portfolio from getting overloaded with hot asset classes that may be about to cool. Second, it forces you to do what investors know they should do but rarely do, namely, buy into assets when they're not all the rage.

You can build this type of portfolio pretty easily. If you don't mind putting together the pieces yourself, you can find pretty much all the different types of funds you need in the MONEY 65, Money Magazine's elite list of recommended funds.

For advice on what percentages of the various funds you should own given your investing time horizon and tolerance for risk, you can check out our Asset Allocator.

Or, you can take the easy way out and buy a portfolio that does all this for you. One type of portfolio that does just that is known as a target retirement fund. Basically, you pick a fund with a target date that corresponds to the year you plan to retire - 2010, 2020, 2030, whatever. That fund then offers a blend of stocks and bonds appropriate for your age.

What's more, the fund gradually shifts toward a more conservative stance - less in stocks, more in bonds - as you approach your retirement date. These funds are about as close to no-brainer investing as you can get, and I think they can be a good deal for investors who don't want to spend time building their own portfolio from scratch. (For more on how these funds work, click here. For target fund recommendations from the MONEY 65, click here.)

Of course, if you really, really think we're headed for a reprise of the early '70s, you can make some of the more specialized bets I outlined earlier. Just remember that if you're wrong, you could end up between a pet rock and a hard place.

__________________

Too cool for a 401(k)? Do the math

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.