investing

Seeking a safe haven for investments

Highlights
  • The better the deal, the more suspicious you should be.
  • You don't know which company may become the next Lehman.
  • Marketers of variable annuities are playing to people's emotions.

In the wake of the financial crisis, almost all investors are looking for safety. As a result, financial firms are peddling a number of investments that promise protection of your principal, regular monthly payouts or guaranteed minimum returns.

But beware, many of these products aren't all they're cracked up to be. Some don't meet their goals, and many charge high fees.

“If anyone is going to guarantee you something, it's going to cost.”

"They may all be appropriate for some investors," says Harold Evensky, president of Evensky & Katz, a financial advisory firm in Coral Gables, Fla.

"But to overplay their safety without risk would be irresponsible. If it all works, you're safe in protecting principal, but there is no guarantee. Some of these clearly have market risk. There is no guarantee managers will achieve their goal."

Among the products touting safety are principal-protected mutual funds and variable annuities.

Definitions
  • Yield curve -- A curve that shows the relationship between yields and maturity dates for a set of similar bonds, usually Treasuries, at a given point in time.
  • Derivatives -- Financial instruments where the value comes from the underlying asset, which could include stocks, interest rates, or currency exchange rates and real estate.

Principal-protected funds

Principal-protected funds aim to do exactly what they're named: protect your principal. Some of these funds have maintained value by switching to bonds from stocks, which have plummeted 56 percent, as measured by the Standard & Poor's 500 Index, since October 2007.

Treasury and municipal bonds have performed much better during that period, of course. But over the long term, stocks have outperformed bonds so staying away from equities could be costly. That's especially the case because, as Evensky put it, "the stock market's gains tend to come in spurts."

Moreover, a fund could be taking risk by holding bonds with long durations. "You want to be careful how far out the yield curve you go," says James Holtzman of Legend Financial Advisors in Pittsburgh.

"Interest rates are pretty much at rock bottom; the only place for them to go is up. The longer you hold the bond, the further the price falls unless you hold it to maturity."

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In addition, "the idea of safety in fixed income is more of an issue given the turmoil and volatility of the past six to 12 months," says Michael Sheldon, chief market strategist for RDM Financial Group in Westport, Conn. He notes that even municipal bonds and investment-grade corporate bonds have suffered for extended periods.

Many principal-protected funds simply consist of structured notes -- often called principal-protected notes -- issued by financial institutions. For example, "one we were looking at paid the S&P 500 return over the next 13 months, excluding dividends, capped at say 30 percent," Evensky says.

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