The One Security You Must Not Buy

Remember The One Stock You Must Buy? It was

1. Small.
2. Led by a dedicated founder.
3. Fiscally conservative.
4. Profiting from a wide market opportunity.

And while it's always a good time to buy a stock that possesses those four core traits -- think of big winners such as Microsoft (NASDAQ:MSFT), Wal-Mart (NYSE:WMT), or Nike (NYSE:NKE) back in the day -- the problem today is that due to the crippling downturn, investors aren't interested in buying any stocks at all.

Is that you?
A recent BusinessWeek article declared it loud and clear: "More investors are shunning stocks." And what are they doing instead? The anecdotal answer from the BW article was cash, and that's backed up by hard data. According to the Investment Company Institute (ICI), equity mutual funds saw net cash outflows of more than $19.8 billion for the first week of March alone.

Now, depending on your individual situation, moving from stocks to cash can be a savvy move. That's particularly true if you're in or within five years of retirement, unable to sleep at night because of stock market volatility, or looking to spend some of that cash in the near term on a home or tuition and need to keep its value stable.

Know, however, that not all cash is created equal.

Say what?
First, if you're hoarding your cash in small bills in your mattress, you're earning no return (and that lumpiness could be what's keeping you up at night). Factor in inflation, and those dollars in your pocket are actually losing value over time.

Now, we've been "lucky" since November in that the current economic downturn has caused inflation to fall to less than 1%. But given the fact that our government is currently printing copious sums of money to pay for stimulus spending, I do not believe that low inflation rates can last.

That fact also makes owning long-term Treasuries a dicey proposition; 30-year Treasury bonds are yielding an absurdly low 3.6% at present. Given historical inflation rates, that means that if you buy one, you're probably dooming yourself to 30 years of less than 1% annual real returns.

Is that a number you're willing to accept for the next three decades?

Warren Buffett wouldn't
Writing in his recent letter to shareholders, Mr. Buffett noted that "The investment world has gone from underpricing risk to overpricing it ... When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."

What he means here is that investors -- individual and institutional alike -- have grown so concerned about protecting their principal, that they're paying enormous premiums (in the form of paltry rates of return) to own government debt. This is particularly dangerous at the 30-year end of the yield curve because as soon as interest rates rise or investors get comfortable with stocks and corporate bonds again, the values of these Treasuries will plummet and you'll be locked in to 30 years of awful returns.

So there you have it: The 30-year Treasury, the one security you must not buy.

But you said
Earlier, however, I noted that you should consider cash if you're in or nearing retirement, fretting volatility, or looking to spend cash in the near term and need it to hold its value. If that's you, still stay away from the 30-year end of the yield curve. Instead, buy something like Vanguard Short-Term Bond (BSV), a liquid ETF that holds Treasuries with maturities that do not exceed three years. Though you'll sacrifice some yield here, you will protect the value of your cash and retain flexibility relative to interest and inflation rates.

After all, your goal in going to cash today is not to earn 3.6% for the next 30 years, but rather to insulate yourself from some of today's wild swings. Short-term bonds will do that without tying up your capital.

One bold prediction for 2039
Because think about what will happen in the world over the next 30 years. We'll pull out of this economic crisis and experience several more bull and bear markets. There will be new technologies and significant changes in the global economy. Fortunes will be made.

At Motley Fool Global Gains, we believe you can earn far better than 3.6% annual returns by focusing on a few obvious, long-term themes like this one: In 30 years, the size of the middle class in China will be far larger than it is today.

We can't find anyone, anywhere who will refute that. And given that the Chinese middle class today numbers somewhere between 100 million and 150 million, that means we're staring down a spending class of (to take a shot in the dark) some 300 million to 500 million people -- a number greater than the current U.S. population.

What companies will benefit from this societal shift? Here are a few we're watching at Global Gains:

You know what to do next
Neither predicting an increase in the size of China's middle class nor finding the companies that will benefit is rocket science, but it will take a disciplined investor like yourself to buy these stocks amid the current volatility and stick with them over the next three decades. Yet if these four stocks on average don't outperform the 30-year Treasury bond through March 2039, I'll eat an entire bowl of "tongue-torching" Sichuan peppers (and we'll post the video here on Fool.com).

If you'd like to read about all of our top China plays and our library of international stock research, click here to join Global Gains free for 30 days. There is no obligation to subscribe.
 
Tim Hanson does not own shares of any company mentioned. New Oriental is a Motley Fool Global Gains recommendation. Microsoft, Starbucks, and Wal-Mart are Motley Fool Inside Value recommendations. Baidu.com and Mindray Medical are Rule Breakers selections. The Fool owns shares of Starbucks and Mindray Medical. Thirty years from now, the Fool's disclosure policy will be struggling through its midlife crisis.