Big yields come with risks attached

Higher-yield bonds and investments may look good in the current low-rate environment, but investors should proceed with caution.


By Emery Styron

Ed. note: This article appeared as part of the CBJ’s subscribers-only Wealth Management special section. Find the full section here.

Return of capital or return on capital – which matters most to you?

Investors seemed to have it both ways just a decade ago, when the nation’s benchmark federal funds rate stood at 4.5 percent. A certificate of deposit holder could sleep peacefully then, knowing his or her nest egg was not only federally-insured, but earning what today would be considered a whopping 4-5 percent return.

Just a year later, the financial crisis struck. Financial markets tanked and the Federal Reserve dropped the benchmark rate to 0.25 percent to stimulate borrowing – sending CD and savings account rates down in turn.

Investors and advisors have scrambled ever since to generate returns of even half 2007’s levels. Rates, though slowly rising, remain near historic lows. That has pushed some investors to explore riskier realms – a strategy that presents some opportunities, and plenty of pitfalls, according to Corridor financial experts.

Further out on the ‘teeter-totter’

“Yields have been so low for so long, people go out further on the risk curve without understanding the risks they’re taking,” observed Tim Hawkins, founder of Hawkins Wealth Management in North Liberty.

He sees investors getting out of safer Treasury notes and bonds and moving “out on the teeter-totter” to high-yield bonds and lower-rated corporate bonds.

He concedes that eking out 1-2 points more return on a portfolio can make a big difference in retirement balances over the long haul, but warns that savers may set themselves back if they aren’t careful.

“We encourage everyone to have a goal. If you’re saving for a house, don’t go chasing yield. The time horizon is too short,” he said. Younger people investing for retirement can take on more risk, however.

“Look at each situation and understand what those funds are earmarked for,” he said.

Back to Blue-Chips

Mr. Hawkins generally advises investing in companies that maintain and increase dividends through good and bad times. He also notes that 10-year Treasury bonds are among the safest investments, pay attractive rates and are backed by one of the world’s best economies.

Tory Meiborg, president and partner with World Trend Financial in Cedar Rapids and Iowa City, agrees. Due to market risk, stocks aren’t a good fit for all investors, but low returns on fixed-income investments make equities with dividends attractive, he said.

For long-term investors, “If you buy a blue chip company that pays a good dividend and reinvest that dividend, you’ll do really well,” he said. Investors should understand that dividends are not guaranteed, and avoid obsessing over a stock’s value fluctuations reported on their monthly statements, he said.

Minimizing costs is another way to generate better returns. “People like the low costs of Exchange Traded Funds (ETFs). That makes sense,” Mr. Meiborg said. He cautioned, however, that the main reason for the buzz around ETFs is that the S&P 500 Index underlying many them has done so well.

“When the S&P 500 drops 10 percent, ETFs will lose some of their popularity,” he predicted.

Combining approaches

Mike Tryon Sr., an advisor at Tryon Investments in North Liberty, said his firm offers a pair of different approaches to help investors realize better yields: A fixed-income model that has averaged 3-4 percent returns over 15 years and private placements.

The fixed-income model uses Vanguard ETFs with low management fees in the 7-8 basis point range. The funds are easy to get in and out of, he said.

An example of private placement is a collateralized, investment-grade corporate bond issued by a real estate developer that yields 7 percent. Mr. Tryon said the bonds “are a little illiquid” but could complement a portfolio of other investments.

All three advisors expect Federal Reserve appointee Jerome “Jay” Powell to continue the cautious approach of current Chair Janet Yellen when he takes over in February, pending Senate confirmation. Under Mr. Powell’s leadership, the Fed is likely to stay on its projected path of raising interest rates three more times next year, while continuing to pare its massive balance sheet of Treasury notes and bonds.

“I don’t think the future will be significantly different than the last two years,” Mr. Meiborg said. He foresees a “slow, incremental increase,” noting that longer-term securities, like the 30-year Treasury have hardly moved at all.

That steady pace may frustrate some investors who are hoping for bigger returns, but Mr. Meiborg counsels caution when it comes to advisors with “easy answers.” “That’s how people get scammed,” he said.

Mr. Tryon has similar advice: “You can watch Bloomberg or CNBC. Half of analysts are predicting a correction, the other half are bullish. People get overloaded with news. Get an advisor and find somebody you trust, who will help you get to where you want to go.”

This article was originally part of the CBJ’s subscribers-only Wealth Management special section. Find the full section here.