There is a lot of confusion and misinformation in the financial press about various kinds of investments. The source of return is not the same for every investment. What is good for one investment may not be good for another investment. I’ll look at three: Gold, Stocks and Bonds.
Gold
Returns from gold are simple to understand. Gold pays neither interest nor dividends. There are storage costs with owning gold which you can think of as a negative interest payment. The only way to have a positive return by owning gold is if the price increases. If you buy gold you want a bull market in gold, i.e. for the price to keep increasing. On the other hand, if there is a bear market in gold you lose money.
The price of gold fluctuates a lot, but in the very long term it rises more or less at the rate of inflation.
Stocks
Understanding the return from stocks is a little bit more complicated. Most common stocks pay dividends. So it is possible to have a positive return from stocks even if the price does not increase. Right now, the broad stock market as represented by the S&P 500 has a dividend yield of 2%, which is historically low. If dividends grow at 5% per year, which is what they have grown at historically, you will experience about 7% return from stocks.
Stock investors can also benefit from price increases, so a bull market can be good for stockholders. Stock investors don’t generally like bear market because they can lose money on their holdings.
On the other hand, in a bear market stocks become cheaper and offer a higher yield, so the potential return is greater. For instance, if the S&P 500 dropped in price by 1/2, the 2% yield would increase to 4% and the potential return would rise to 9%. For that reason, investors making periodic stock purchases should prefer a bear market in stocks.
So I will say that, although stock investors fear bear markets and cheer bull markets, they really should be indifferent to bull and bear markets cycles.
Bonds
Bonds, CDs and other fixed-income investments pay interest which is the source of their return. With a bond, you lend $100 to some institution either the U.S. Treasury, a corporation or a bank. They pay you interest periodically and at the end of the term give you back your original $100.
Bondholders generally don’t see any return from price appreciation because when the bond matures they return your principle. There really can’t be a “bull market” in your bond but their can’t be a “bear market” either. You just get your money back, provided the bond issuer doesn’t default.
Now there are speculators that try to make money buying and selling bonds, but that’s speculating, not investing. Their idea is to buy bonds cheap and then sell them if the price goes up.
Sources of Return
So here are three general kinds of investment gold, stocks and bonds with different sources of return.
| Asset | Source of Return | Favorable Market |
|---|---|---|
| Gold | Price Appreciation | Bull |
| Stocks | Dividends + Price Appreciation | Bull or Bear |
| Bonds | Interest | Bear |
Now what you will read in the financial press is that all investors want a bull market all the time. As you can see this is misinformation. Gold investors do want a bull market, but stock investors should be indifferent and bond investors want higher interest rates which some people like to call a bear market in bonds.
The views expressed in this article are those of the author and do not necessarily represent the views of Laguna Beach Bikini, its editors, staff or any other organization.
