Investing new economy » Savings strategies in a low-yield environment
You can't blame investors for feeling frightened these days.
Many experts see inflation and interest rates heading higher. Already, surging oil prices have helped push the annual inflation rate above 2 percent. And the global picture is full of turmoil -- from war in Libya to natural disasters in Japan.
In this environment, devoting some of your assets to safe fixed-income investments makes more sense than ever. There's a wide range of possibilities, depending on what you consider safe.
"Based on the uncertainty with respect to interest rates and potential inflation, we're continuing to use fixed income," says Michael Dixon, director of wealth management at Carl Domino financial advisers in Palm Beach, Fla. "But we're very cautious with the ratings of securities and durations."
The lowest-risk options, such as certificates of deposit, or CDs, and Treasury securities, offer paltry yields, while vehicles at the top of the income scale, such as high-dividend blue-chip stocks, are much riskier.
"You give up yield for safety. That's the biggest problem with fixed-income investments today," Dixon says.
Advisers agree that the basic bond strategy for a time of rising inflation and interest rates is high quality and short maturities. That's because short-term bond prices drop less than long-term bonds in an environment of rising inflation and interest rates. And high-quality bonds fall less than low-quality bonds.
Ladders, Treasuries, corporates, munis
Patti Houlihan, president of Houlihan Financial Resource Group in Reston, Va., recommends a "laddered" bond portfolio, which encompasses a range of different maturities. That way your bonds mature at regular intervals, so if interest rates rise, you can reinvest at higher rates. "It immunizes clients from interest rate risk," Houlihan says.
Treasuries are the highest-quality bonds, because they're backed by the federal government. But even a five-year Treasury note yields little more than inflation. "Treasuries are safe for payback, but not for investment return opportunities," says Chris Larkins, senior investment adviser at HPM Partners in Cleveland.
Corporate bonds offer higher yields than Treasuries. If you're looking for safety, you'll want to stick to investment-grade corporates. In general, the higher a company's credit rating, the lower the interest rate on its bonds -- and the lower the chances of a default.
Investors have shied away from municipal bonds in recent months, as the financial difficulties of many states and localities have led some economists -- most notably Meredith Whitney, who accurately predicted the downfall of several big banks in 2008 -- to predict massive defaults. But many advisers say those fears are overblown.
"We aren't scared off by munis," Larkins says. "Will the federal government really allow widespread defaults by state and local governments? The default rate historically is 0.2 percent or less. Some defaults may well occur, but sticking to high-quality issues lessens your risk."
TIPS, bond funds
Treasury inflation-protected securities, or TIPS, represent an option to protect yourself from inflation. They are Treasury bonds with a twist. The value of these securities and their interest payment rise with inflation and fall with deflation. The yield remains constant. When TIPS mature, you are paid the greater value of the adjusted principal or the original principal.