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Richard Barrington

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Look Before You Leap: There Are Dangers Outside the Stock Market Too

Posted: 06/30/10 01:18 PM ET

"Stop the market--I want to get off."

No one could blame you if you felt that way. From the beginning of April through mid-June, the Dow Jones Industrial Average had 15 days in which it lost over 100 points each. It was scant comfort that there were also 11 days during that span in which the Dow gained over 100 points. That's simply served to underscore the erratic behavior of the stock market in recent weeks, and kept investors focused more on risk than reward.

When risk is on people's minds, they start to look for safer harbors: calm places where they can put money until the stock market settles down. However, it is important to examine each alternative from a risk management standpoint--otherwise, you may not find the safety you're looking for.

Alternatives to the Stock Market

Here are some examples of the pros and cons of popular alternatives to stocks:

  • Gold and other commodities. When markets are ailing, gold is often sold as something as of a wonder drug. However, the gold bubble looks hauntingly like the dot-com bubble, the real estate bubble and the oil bubble that preceded it. Even some commentators who are bullish on gold describe it as a bubble that will get bigger before it pops, but playing chicken with the financial markets is no way to find a safe harbor.
    Commodities have their place, especially as an inflation hedge under current circumstances. But don't overload on any one commodity, because commodities can be every bit as volatile as stocks. With everyone's favorite commodity having already tripled in price over the past decade, don't fall for fool's gold.
  • Bonds. Since bonds and stocks often (but by no means always) move in different directions, bonds are a popular safe haven when the stock market gets scary. Even so, pay particular attention to who is issuing the bond. Corporate bonds may expose you to the same economic risks as stocks. Municipal bonds are a minefield of budget difficulties.
    Concentrate on general obligation bonds of fiscally sound municipalities with growing tax bases. US Treasury bonds are the safest call, but with short-term yields under 20 basis points (0.20%), they don't offer you much beyond safety. Longer-term Treasuries have higher yields, but their prices can fluctuate more, so there is no guarantee you'll be able to sell them at a good price when you are ready to go back into stocks.
  • Savings, money market accounts, and other deposit vehicles. As long as you stay within FDIC limits (currently $250,000 per depositor per institution, and it looks like that number might become permanent), deposit accounts offer true safety, and bank rates are a little bit higher than short-term Treasury rates.

    Still, even plain-vanilla deposit accounts require smart shopping. Even though long-term CD rates are likely to be the highest bank rates you see, in this situation you shouldn't lock your money into a long-term CD unless the penalty for early withdrawal is negligible. Otherwise, you might not be able to get at your money when you are ready to get back into the stock market.
    As a general rule, money market rates tend to run higher than savings account rates, and they reward you especially well for opening a jumbo account ($100,000 or more). No matter which account type you choose, be sure to shop around--bank rates vary greatly from one institution to another and are subject to frequent changes. Going with the first savings account you see could very well mean you're leaving free money on the table.

Beyond the individual advantages and disadvantages of the above alternatives, keep in mind that making wholesale moves in and out of the market is also inherently risky. Market timing doesn't work, but sensible, value-based asset allocation can be an effective investment approach.

Try to make your moves in and out of the market incrementally, selling more when prices are up and buying more when prices are down. And, when you do pull money out of the market, make sure you are moving towards safety and liquidity rather than more risk.

The original post can be found at MoneyRates.com: Look Before You Leap: There Are Dangers Outside of the Stock Market Too