The first rule of investing is always ‘safety,’ but with inflation hovering around 2 to 3 percent, bank-guaranteed products like CDs and savings accounts are actually losing money net of inflation.
So where can investors find a safe harbor in a storm without taking on too much market risk? Here are some important ideas:
Annuities come with the advantage of a contractual guarantee. This is what sets annuities apart from investment products: The insurance company issuing the contract takes on some or all of the market risk. If the stock market or bond market crashes, the annuity company is still obligated to fulfill its promises to the annuity holder. No mutual fund, stock or bond can offer that guarantee in writing. This is what sets annuities apart.
Where safety of capital is absolutely required, you may wish to consider fixed annuities which are designed to provide a guaranteed annual rate of return, regardless of market events.
Fixed annuities are appropriate for those who want a guaranteed rate of return on money they won’t need for several years. If you need to guarantee a set minimum amount of income for life or for the joint lifetimes of yourself and another loved one, and you will need the income to begin starting immediately, you may consider a lifetime income annuity. Both of them are guaranteed to deliver as promised, regardless of what happens to the economy or the stock market as long as the insurance company is solvent.
Annuity assets grow tax deferred, as long as you leave them in the annuity. An early withdrawal penalty of 10 percent may apply if you are under age 59½.
For maximum safety, work with your insurance professional to select annuities from carriers with very high ratings for financial stability and liquidity.
Bonds are simply IOUs from a corporate or government borrower to a lender. While some bonds, usually called “high yield” bonds, come with substantial market risk, many of them come from very solid, established corporations with decades of consistent earnings that are more than enough to cover interest payments, and pay back the loan when the bond matures.
The safest bonds from this perspective are U.S. Treasury bonds which have generally unquestioned credit quality. Because the U.S. Treasury has both the power to tax and to print money to cover obligations, U.S. Treasury bonds are generally considered the gold standard. Bond prices may fluctuate over time – the longer the bond’s duration, the more you can expect the bond price to fluctuate. Scheduled interest payments and the return of capital are assured.
Municipal bonds – those issued by states and cities – feature interest income free of federal taxation. These are popular among individuals in higher tax brackets.
Corporate bonds – Those interested in safety may consider investment-grade bonds. There is an element of risk here so planners look for bonds from companies with long records of consistent earnings sufficient to pay interest and return the face amount of the bond at maturity. In the worst case event – the bankruptcy of the company – planners look for companies that have solid price-to-book ratios, so that even if the company had to sell all its assets tomorrow, they would be able to raise enough cash to make bondholders whole.
3) Bond mutual funds
These are just mutual funds with many bonds in them. Safety-conscious investors may consider a short-term bond fund for price stability. With mutual funds, there is no single maturity date on which you can expect to receive a specific lump sum. If you need that feature, consider buying a bond.
If not, your advisor can help you construct a diversified portfolio of bonds and bond funds to help you meet your financial needs while keeping risk down.
4) Money markets
Money markets are essentially mutual funds that focus on very safe, liquid, short-term investments, intended to maintain a stable net asset value of $1 per share, no matter what happens to the markets. Money market portfolios typically consist of short-term treasuries, high quality, short-term corporate debt and commercial paper. Unlike CDs, money market funds typically do not come with FDIC insurance but they have historically been very safe places to park cash.
The right safe money investment or combination of investments for you depends on your own individual situation, including your risk tolerance, time horizon and your need for income. To get started constructing the ‘safe money’ portion of your portfolio, contact your agent today.