With the stock market dropping almost every day lately, a lot of nervous investors are looking longingly at the sidelines. Even professional investors have started to get bearish about the future prospects for stocks.
But before you hit that sell button, make sure you take a look at the other side of your trade. Once you've sold your stocks, what are you going to do with that cash? After looking at the alternatives, you might well come to a different conclusion about whether stocks are such a bad investment right now.
The current mood on stocks is a big change from what we saw less than a month ago. Coming off a six-month rally, investors grew complacent and fearless. Between their highs in early October 2011 through the end of April, the iPath S&P 500 VIX Short-Term Futures ETN (NYS: VXX) , which tracks volatility measures, fell about 75%, while the leveraged VelocityShares Daily 2x VIX ETN (NYS: TVIX) lost almost 95% of its value.
But in May, fear has come back into the stock market, and many investors are responding by reaching for the sell button. Those same volatility ETNs are up 25% and 40%, respectively, since May 1, making conservative investors wonder whether it's time to get out of stocks now before things get any worse.
Where can you hide?
Whenever you sell an investment, you should also focus on what you're going to do with the money instead. Even if you're right about selling out, it does you no good if the alternative is worse.
The obvious alternative to stocks is cash. Bank accounts, Treasury bills, and other cash equivalents give you the security of knowing you can never see a loss of principal. With the Dow down more than 5% since May 1, that's a comforting guarantee.
But short-term Treasury bills pay less than 0.1% right now, while many bank accounts don't even get that far. Top-yielding savings accounts from CIT and Barclays (NYS: BCS) yield 1% as the banks are willing to pay above-average rates to draw savers in, but at that level, you'll fall well short of breaking even after inflation and taxes.
Reaching for more
So to avoid the surefire inflation-adjusted loss that savings accounts represent right now, you might look to other choices. But consider their pros and cons:
- Bank CDs are just as safe as savings accounts. But even the highest-yielding five-year CDs listed on Bankrate earn less than 2% annually, and you commit to locking up your money for a long time. You'll face substantial fees if you pull your money out early.
- Gold has acted as a safe haven in times of turmoil in the past. But this time around, gold has actually underperformed stocks, and the silver-tracking iShares Silver Trust (NYS: SLV) has done even worse as the combination of a potential slackening in industrial demand and bad investor sentiment take away interest in the white metal. Even longtime gold bulls like Jim Rogers believe that gold's near-term prospects are as bad as or worse than what some analysts are predicting for the stock market.
- Various bond investments have different appeals and problems. Treasuries don't yield anything more than bank CDs do, making them an inferior choice. Even high-grade corporate bonds don't give you much of a boost over Treasuries, with IBM (NYS: IBM) having recently sold three-year notes at 0.75% and seven-year bonds at 1.875%. Meanwhile, in the high-yield corporate realm, you can find some more attractive yields, but you have to be careful to assess whether you're willing to take on the higher credit risk associated with their issuers. Most importantly, the threat of higher interest rates hangs over the entire bond market and could eventually cause price declines that would rival a bear market in stocks.
- Commodities other than gold have seen mixed performance recently. But crude oil has seen big price drops lately, setting the stage for a change in profitability that could reverse huge portions of the growth in the energy industry in recent years.
As you can see, all of these investments have their downsides. The question is whether their potential benefits outweigh them. Your answer to that question may be different from anyone else's, because it depends a lot on your particular financial situation.
But with many individual stocks offering solid dividend income and less volatility than the overall market, you can't count stocks out automatically. After looking at your portfolio, you may decide that keeping the stocks you own -- or switching into others that are better -- could be a far better choice than selling out and expecting financial Armageddon.
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At the time this article was published Fool contributor Dan Caplinger is comfortable with his asset allocation right now. You can follow him on Twitter. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of IBM. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy will never dump you.
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