Low-Risk Investors Don’t Have Choices

Dominick Tallarico is 63 and so close to retirement that he’s in no mood to take chances with his money.

“I don’t think these problems in the economy are over yet,” he said. But when he scoured the market for a CD or U.S. Treasury bond that would be “safe and pay me some interest,” he came up short. He found interest rates below 2 percent, hardly the type of income he thinks he could live on if inflation clicks in during the years ahead.

“I guess there’s no place safe,” he concluded.

By taking measures to keep interest rates on U.S. Treasury bonds at almost nothing, the Federal Reserve is trying to induce people to take more chances with their money. Economists say the nudging could drive up the stock market and maybe give corporate decision-makers the confidence to buy equipment and hire people. But that leaves retirees, who tend to try to protect savings from losses, in a rough spot.

“If you want to be a low-risk saver, there is nothing for you,” said Gregory Seals, director of fixed income and behavioral finance for the CFA Institute. But for those driven to try to increase their income, while assuming more risk, bond experts such as Seals suggests combining riskier bonds with safer bonds so they buffer the risk somewhat and position their money to earn more interest.

It’s not a flawless strategy, said Charles Farrell, a Denver financial planner, who faults the Federal Reserve for trying to push people into high-yield bonds and stocks that could turn into losers.
If the economy goes into a double-dip recession and the stock market plunges, investors could incur sharp losses on higher-risk bonds. It’s a risk Seals acknowledges. But, he said, investors need to realize the risks they are taking in U.S. Treasury bonds or mutual funds that invest in the safe bonds.

Although the Federal Reserve seems intent on keeping interest rates low for at least six months to a year, the assumption is that eventually those rates will go up. And when interest rates go up, it will force the price on bonds people purchased recently to fall.

So, said Seals, if a person buys a five-year Treasury bond and interest rates go up 1 percent, the price of the bond will go down about 4.5 percent. That won’t hurt an individual who is holding the bond until it matures. But if the person worries that the interest rate won’t cover the rising cost of living and wants to sell the bond, he will lose money when he sells it.

If the investor buys a 10-year Treasury bond now, and interest rates go up 1 percent, the pain would be worse. Seals notes the bond price would fall about 8 to 9 percent. Bond prices act according to a mathematical script and depend on interest rates.

So Seals and other bond experts are telling individuals to be wary about trying to get a little more yield by buying bonds that mature over a long period. A 10-year Treasury was recently yielding about 2.5 percent compared with a 5-year Treasury at 1.1 percent. But since the price falls more sharply on longer-term bonds than short-term bonds, investors need to realize the extra yield might not compensate for the loss they will take if interest rates jump sharply and bond prices plunge, Seals said.

He suggests another solution for people willing to take on more risk: Hold a combination of various bonds, everything from corporate bonds to foreign bonds, he said. A diversified bond fund will often create these mixtures for investors. For example, Mark Kiesel, managing director and portfolio manager for Pimco mutual funds, said he is blending bonds from many countries. He prefers those from some Asian and Latin American countries over those from the U.S. and Western Europe because some emerging markets are stronger financially than developed markets.

Although Pimco invested heavily in U.S. Treasury bonds a few months ago, Kiesel said, “Treasury gains are over.”

Still, Kiesel acknowledges risks. If the U.S. and Europe go back into a recession, emerging markets will hurt, too, he said.

Meanwhile, Farrell is not inclined to take those risks. He notes that while investors don’t like settling for a 2.5 percent interest rate on a safe bond, they need to think beyond the one bond they might be buying. Usually, investors hold multiple bonds, so they have other bonds from previous periods, too, perhaps some paying 6 percent.

And with time, Farrell said, investors will be able to add higher-yielding bonds if interest rates go up.

Knowing when, however, is anyone’s guess. At the beginning of this year, the consensus view was that rates would be climbing now, not falling.

SOURCE: McClatchy-Tribune Information Services (c) 2010