Here’s your choice: Take on lots of risk and hope for the best or watch your standard of living erode.
The stock market has been soaring, thanks to the Federal Reserve Board’s quantitative easing program, which has continued to hold interest rates at or near record lows for several years now.
Investors came back into the market, not because the market was showing signs of strength, but because it became the least objectionable place for investors to put their money.
A 12-month certificate of deposit (CD) is yielding 1.25% interest today. The U.S. inflation rate rose to 2.7% in March and is continuing to rise – a deliberate outcome of Fed policy. So the real rate of return, in exchange for tying up your money for a year, is negative 1.45% (2.7% – 1.25%).
Conversely, The Russell 2000 Index of small-cap stocks recently hit a new high, having jumped 150% since March 2009, including a 9.5% gain so far for 2011.
Small-cap stocks are, of course, the riskiest stocks, representing companies with market capitalizations of $2 billion or less. And the higher small-cap prices soar, the riskier they become and the more likely it will be that we will see a market correction.
What will happen when quantitative easing ends? What will happen when market conditions, rather than Fed programs, dictate returns?