It’s been a tumultuous year for financial markets.
The S&P 500 index plunged 11% in the first 6 weeks of the year amid concern about global economic weakness. Since then, stocks have rebounded to a record high, as the U.S. economy has strengthened.
The 10-year Treasury yield dropped to a record low of 1.34% July 6, as the U.K.’s vote to exit the European Union panicked investors around the world. But the yield has bounced back, as markets surmise the impact may be limited.
Oil prices slumped to a 13-year low of $26.21 a barrel in February before nearly doubling by June and then slipping back to $45 in September. Traders have been whipsawed by conflicting stories about supply and demand.
The U.S. presidential race has sparked concern about what a Donald Trump presidency might mean for the health of the global economy and financial markets. And a recent survey by Bankrate shows the majority of Americans are concerned about the election’s effect on the U.S. economy, regardless of who wins.
So how can investors find stability in this sea of volatility? Are there safe investment choices? Bankrate spoke to financial advisers about several possibilities: Treasury bonds, municipal bonds, investment-grade corporate bonds, annuities, dividend stocks, domestic (rather than foreign) stocks, certificates of deposit and online savings and money market accounts. Advisers cited pros and cons for each category.
The main benefits of Treasuries are that you are guaranteed to receive par value for the bonds at maturity and interest payments along the way. Treasuries are the epitome of safe investments, backed by the full faith and credit of the United States — unless, of course, the government goes belly up.
“I’ve been a fan of Treasuries for most of my career — more than 30 years,” says Mick Heyman, an independent financial adviser in San Diego. “Why buy anything else for bonds when Treasury yields aren’t that different from other safe paper?”
“The problem is the Treasury yield is very low,” says Michael Sheldon, chief investment officer at Northstar Wealth Partners in West Hartford, Connecticut. “And interest-rate sensitivity (duration) is historically high. So when interest rates rise sometime in the future, investors will face the risk of big capital losses” if they own Treasuries in a mutual fund or don’t hold their Treasury bonds to maturity.
Muni bonds aren’t quite as safe as Treasuries. Witness the bankruptcy of Detroit in 2013 and Puerto Rico’s current woes. “But historically, defaults are few in the municipal bond space,” Sheldon says. Only 4 muni issuers rated by Moody’s Investors Service defaulted last year, after zero in 2014.
A major appeal of munis is that the interest income they provide generally isn’t subject to federal income tax. And if the muni was issued by the same state in which the investor lives, the income isn’t subject to state tax either. Experts say munis often make sense for investors in the 25% tax bracket and higher.
“Munis are still attractive relative to taxable bonds, such as Treasuries and corporate bonds, for high-income investors,” says Dan Heckman, national investment consultant for U.S. Bank Wealth Management in Kansas City, Missouri.
“But munis are relatively expensive after the gains of the last few years,” Sheldon says. So investor caution is warranted.
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Investment-grade corporate bonds
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The selling points for these bonds: Their yields are higher than those of Treasuries and they’re safer than high-yield corporate bonds and stocks. “If you don’t need more than a 2.5% to 3% return, you don’t need to look for high-yield bonds,” and can stick with investment-grade corporates, says Cary Guffey, a financial adviser for PNC Investments in Birmingham, Alabama.
If you don’t need more than a 2.5% to 3% return, you don’t need to look for high-yield bonds.
Heckman favors the financial services sector for these bonds. “Financial companies’ bonds look cheap,” he says. More stringent capital requirements from the government have helped shore up banks’ balance sheets, he points out. “That hurts return on equity but is good for bond prices.”
However, an increase in interest rates would push the value of the corporate paper down. And the fact that many companies have loaded their balance sheets with debt to fund stock buybacks makes Heckman worried about the safety of their bonds.
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Annuities are contracts signed with insurance companies that give holders regular income payments, sometimes for the rest of their lives, in exchange for a lump-sum contribution. Fixed annuities pay out distributions at a pre-set rate, while the payout for variable annuities can change, depending on the underlying investments.
There are income annuities, which allow you to begin receiving income immediately. And there are deferred annuities, which allow you to put off income payments until a later date, saving you from having to pay taxes on your earnings until then.
“Until recently, I always believed that a portfolio of bonds could provide you annuity-like payments, so you didn’t need the insurance product,” Heyman says. “But in this period of lower interest rates, more volatility and difficulty in figuring out how to get a decent guaranteed income, it makes more sense for people to consider them.” Some fixed annuities now offer interest rates of 5% or more.
But annuity fees can be high. “Another drawback is that you are locking up your money and can be subject to surrender charges” if you cancel the contract early, Heckman says.
With some blue-chip companies offering both yields of more than 3% and the possibility of a rising share price, this is an investment that could work well, advisers say. “I believe dividend stocks can be the core part of a portfolio oriented toward safety and quality,” Heyman says.
When choosing dividend stocks, it’s better to look for companies with a history of dividend increases rather than the ones with the highest yields, advisers say. Dividend increases generally result from profit growth, says Tim Ghriskey, co-founder of The Solaris Group in New York City.
Meanwhile, extremely high yields are often a sign of a company in trouble: The yield is high because the share price is low. “You’ll want companies that consistently raise their dividends and have a decent yield — something above 2%,” Ghriskey says. “Once you get above 5%, you want to do your homework to see if there’s risk of a dividend cut.”
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Domestic stocks over foreign ones
Some investment experts recommend foreign stocks as an important element in any diversified portfolio. But others aren’t so sure. First, there’s a currency issue. If the dollar strengthens, foreign shares denominated in their native currency are worth less in dollars. To be sure, buying dollar-based foreign shares — American Depositary Receipts, or ADRs — eliminates that problem.
But another issue is sluggish economic growth and political turmoil overseas, such as the Brexit vote in the U.K., which has buffeted stock markets overseas. China, struggling with slowing GDP growth, has seen its Shanghai Composite Stock Index drop this year. Meanwhile, the stagnant European economy has pushed the Stoxx Europe 600 index down.
“For the past several years, the U.S. has been the best performer in the equity market universe as a result of the uncertainty overseas,” Sheldon says. And if you own U.S. large-cap stocks, you already have a foreign exposure, as these companies are dependent on overseas markets for much of their sales.
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Certificates of deposit
With a basic CD, you deposit your money in a bank for a set period of time — generally 3 months to 5 years — and receive a pre-set interest rate in return, plus your money back when the CD matures. The best rates on CDs generally come from online banks, because their costs are lower than their brick-and-mortar counterparts.
One of the most appealing features of CDs is that they are FDIC-insured, up to $250,000 per depositor per bank. “The great thing is that as long as you stay within the limit, you have full FDIC coverage,” Guffey says.
The downside, apart from the low return, is that you will be penalized if you withdraw money from your CD before maturity. The penalty is typically 3 to 6 months’ worth of interest payments. “This may not be a suitable investment for emergency funds,” says Tom Fredrickson, a financial planner with the Garret Planning Network.
Considered quintessential safe investments, bank savings accounts and money market accounts offer lower interest rates than CDs, but you are allowed to withdraw your funds without penalty, though there are often limits on the frequency of withdrawals.
Just as with CDs, savings accounts and money market accounts are FDIC-insured.
Money market funds may sound similar to money market accounts, but they are mutual funds, and they aren’t insured. “The average money fund yield is currently 0.23%,” says Peter Crane, president and publisher of Crane Data – “Money Fund Intelligence.” That reflects the average of the 100 largest money market funds that Crane tracks.
“For money that could be needed quickly, I recommend online bank accounts or money market funds” over CDs, Fredrickson says.
Inflation is an important risk to consider for savings and money market accounts or funds. “Inflation could run at a higher rate than your return,” Guffey says.
Consumer prices rose nearly 1.1% in the 12 months through August.