As rates fall, the investment theme for the '90s becomes risk vs. reward

August 09, 1992|By James Russell | James Russell,Knight-Ridder News Service

"Are you satisfied with less than 4 percent?" asks a newspaper advertisement for PaineWebber.

"If you're tired of watching CD rates go down, take a look . . .," NTC says a Scudder Investment Services ad.

Investing has been awash with suggestions since the high interest rates of the past have dwindled. But the risk often is played down.

"The higher the return, the greater the risk" is a maxim that is especially appropriate in times like these. Risk vs. reward has become the financial theme of the 1990s.

The greatest safety lies in low rates of return, such as those provided by federally insured certificates of deposit, insured accounts at banks and savings institutions, short-term U.S. Treasury securities and money market mutual funds.

The low rates -- six-month CD rates hover around 3.5 percent -- hurt conservative investors.

Once you leave the low-interest-rate area, the potential rewards are better. But the risk is greater.

Stocks with high price-to-earnings ratios, selling for perhaps 30 or 35 times what the company is earning in profit, generally are considered high-risk investments. For example, some of last year's high P-E health care stocks plummeted this year as investors opted for lower risk.

Low-rated junk bonds that pay much higher rates than other bonds are risky.

There is a middle ground: Asset diversification, a strategy based on old advice: Don't put all your eggs in one basket.

Any reputable investment firm or financial institution can help you maximize return while minimizing risk.

Competent advisers know that over long periods stocks beat all other investments.

Salomon Brothers, the New York firm, recently measured the performance of 13 investments over one-, five-, 10- and 20-year periods. In the 10- and 20-year spans, stocks did best and bonds second-best among the most popular investment areas.

In the past 10 years, stocks showed a compound annual rate of return of 18.4 percent, while bonds came in at 15.2 percent. Over 20 years, the result was stocks 11.5 percent, bonds 9.3 percent.

Diamonds, Old Masters paintings and Chinese ceramics beat bonds slightly over 20 years. But they can't be sold easily, as securities can.

"The 1980s were an extraordinary period for both stock and bond performance," said Steven Norwitz, vice president of the T. Rowe Price mutual fund group in Baltimore.

He said the Price strategists stress diversification as "a recipe for investment success."

Consider a balanced, moderate-risk portfolio: 35 percent stocks, 35 percent Treasury bonds, 30 percent Treasury bills.

A 10-year investment of $10,000 in the diversified portfolio grew to about $36,000 -- $16,000 more than the T-bills but $14,600 less than the all-stock approach, Mr. Norwitz said. Over the past 20 years, the diversified portfolio rose to $67,500, more than the $43,000 the T-bill collection earned but less than the $94,000 the all-stock plan amassed.

Those results might remind you of the tale of the three bears and their porridge. The stock portfolio was too hot, or risky. The T-bills were too cold, or unproductive. The diversified portfolio was just right, offering generous return with moderate risk.

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