In this sluggish economy the Federal Reserve has adopted an accommodative policy and is not expected to increase interest rates until sometime in 2014. This has been very frustrating for investors who have their money in banks and credit unions. Those investments offer principal protection (thus low returns) by the FDIC of up to $250,000 in the event the institution fails. Below is a discussion of a few popular investments that investors have used to increase their returns and some key items to know about each of them.
- Fixed Annuities – A fixed annuity is a contract with an insurance company. They can be purchased at a bank or credit union and do not offer FDIC insurance. Your principal is guaranteed by the specific insurance company. Key to know: Fixed Annuities carry surrender charges, withdrawal limitations and interest rate provisions, all of which should be fully disclosed by the selling agent and understood by you before purchase. Work only with Insurance Companies that have an A or better credit rating. Be wary of contracts that offer high first year rates as they are usually dropped below market rates in subsequent years.
- Individual municipal and corporate bonds – These are essentially IOUs issued by corporations and municipalities. Each bond has a specific interest rate and maturity date. Your principal is backed by the financial strength of the issuing entity. There can be certain tax benefits to owning municipal bonds. Key to know: The lower the credit rating of the bond, the higher the interest rate to compensate you for taking on default risk. The bond market is not as efficient as the equity market, leaving room for price manipulation. Always ask what the markup is on the bond you are buying or selling. Be cautious when you are purchasing bonds with high coupon rates. Know the credit rating on the bond and any provisions associated with it (calls, maturity).
- High Dividend Equities – With the low interest rates, a number of investors have turned to using individual common stock to increase their returns. This is a very different investment than a bank or credit union investment because your principal will fluctuate and there is no guarantee you will get your principal back. Key to know: Equity investing has a higher level of risk than bond investing. There is no provision that says the company has to pay your principal back. Your principal will increase or decrease based upon market forces and the success of the underlying business. Determine if you want to own the business the company is in before considering a purchase based on the specific dividend. Understand also that the company has no obligation to pay a certain dividend amount and may increase or decrease it.
- Master Limited Partnership (MLP) – This is a very sophisticated investment which acts like a stock and typically has higher payouts based upon the underlying business. The tax implications of an MLP are complicated and require full knowledge of their implications before investing. Key to know: These investments depend on the underlying business to sustain their payouts to investors. In addition, changes in favorable tax legislation and increasing interest rates could cause the value of the MLP to decline. Investors need to understand fully how the current payout is being generated and if the price of the MLP has been inflated based upon current demand. There are no principal or income guarantees associated with this type of investment.
I have only touched the surface in discussing the common investments which investors and savers are using to increase their yield due to the current low interest rate environment. I strongly recommend that before the investor uses any of these alternatives, they educate themselves more fully on the intricacies of the specific investment they are considering. If the investor is not comfortable doing their own research, then I strongly suggest that an investment professional be consulted. Remember that the old adages, “No Free Lunch” and “No Risk, No Return” apply.
The author of this article, George S. Urist, MBA, CFP® is President and Owner of Urist Financial and Retirement Planning, Inc., located in East Syracuse, New York. George Urist has been a CERTIFIED FINANCIAL PLANNER™ practitioner and Registered Representative with LPL Financial for over 24 years. George can be followed on twitter @gurist and can be reached at 315-445-2147 or at firstname.lastname@example.org. Securities offered through LPL Financial. Member FINRA/SIPC