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Don't Let Bernanke Pick Your Pocket!

By: Motley Fool
Posted: 5/31/2011 11:04:00 AM
Referenced Stocks: GD;LLY;TLT;VIG;VYM

This month, the rate of inflation exceeded the yield on the 10-year Treasury bond for the first time since 2008. That's a negative real yield! Your assets will lose purchasing power with that return. Bill Gross, who manages the world's biggest bond fund, told Bloomberg Television last week: "Savers are being disadvantaged. ... We call [what policymakers are trying to do] pocket picking." Don't let central bankers pick your pocket. Here are a few asset allocation guidelines to avoid just that.

Saving is healthy -- necessary, even. Indeed, during the housing bubble , there was spending on a massive scale, with people borrowing against the value of their home to fund their spending habits. Now that the party is over, U.S. consumers are left licking their wounds ... or balance sheets, as it were.

Avoid cash and government bonds
However, by setting interest rates at zero, the Federal Reserve isn't making it easy for people to save -- that's the idea. With negative real Treasury yields , saving intelligently for the long term means avoiding cash instruments (T-bills, money market funds, etc.) and Treasury bonds (I'm not referring to an emergency fund here). With regard to government bonds, the longer the maturity, the more interest rate risk you take. Steer clear of the iShares 20+ Year Treasury Bond ETF ( TLT ) , for example.

If you have money in a corporate bond fund that is run by a competent manager who you are comfortable with, that's an acceptable choice.

Favor real assets -- at the right price
There is only one reason to have your long-term savings in cash right now: because you're waiting for asset valuations to become more attractive . Otherwise, you should be investing those funds -- very selectively -- in real assets (assets that can be expected to provide a return above the rate of inflation , such as stocks or real estate.) In a stock market that looks overheated to me, high-quality large caps are one of the few segments that offer decent value. Two good alternatives to take advantage of that are the Vanguard Dividend Appreciation ETF ( VIG ) and the Vanguard High Dividend Yield ETF ( VYM ) .

High quality, still
Finally, if you have the time and the inclination, you can invest in individual stocks. For the reason I gave in the previous paragraph, I would suggest concentrating on micro caps or special situations (if you have enough expertise) or high-quality large caps (which is easier). It's hard for me to believe that franchises like Cisco Systems (Nasdaq: CSCO) , Intel (Nasdaq: INTC) , General Dynamics ( GD ) , or Eli Lilly ( LLY ) -- all of which offer a forward earnings yield of more than 10% -- won't produce at least 5%-6% in annualized return above the rate of inflation over the next five to seven years.

The stock market looks overheated -- " Watch This Before the Market Crashes ."

Fool contributor Alex Dumortier holds no position in any company mentioned. Click here to see his holdings and a short bio. You can follow him on Twitter . The Motley Fool owns shares of General Dynamics and Intel, has created a bull call spread position on Cisco Systems, and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Cisco Systems and Intel, as well as creating a diagonal call position in Intel. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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