Alternatives to Bonds
Many investors consider bonds to be one of the safest investments. You may have even heard that they have a “guaranteed rate of return”. The fact is, bonds are a lot riskier than you have been led to believe. Even treasury bonds don’t come without risks. There are many alternatives to bonds, including CDs, REITs, precious metals, cryptocurrency, ETFs, floating rate funds, and life insurance. Each investment has its own benefits and drawbacks. An experienced financial advisor will be able to help you craft a portfolio that aligns with your goals and risk tolerance.
Are CDs (Certificates of Deposit) worth it?
Simply put, money put in a bank won’t grow any significant amount. It’s important to keep some money in a savings account for emergencies (about 3 to 6 months’ worth of expenses). But as far as long-term investments go, Certificates of Deposit aren’t your friend.
Currently, most CDs don’t even have a 1% interest rate, and therefore don’t keep up with inflation over the long term. Compare that to the stock market, which has had an average annual return of 10% over the past century. There is also another disadvantage to CDs, the early withdrawal penalties. If you need to withdraw your money before the CD matures, you’ll have to pay. However, there are a few benefits to Certificates of Deposit. They’re very safe investments since they’re insured by the FDIC up to $250,000 per account. They can also be used to teach children about saving money and financial responsibility.
But when it comes to saving for retirement, you shouldn’t be relying on CDs.
REITs (Real Estate Investment Trusts)
REITs are a way to invest in the real estate market without having to actually purchase property. When you invest in a REIT, you’re buying shares of a company that owns or finances income-producing real estate.
There are many different types of REITs, but most of them can be classified as either equity REITs or mortgage REITs. Equity REITs own and operate properties, while mortgage REITs lend money to real estate owners and operators. Both types of REITs are required to distribute at least 90% of their taxable income to shareholders in the form of dividends.
The main benefit of investing in REITs is that they offer a high rate of return. Some are advertised as having insane rates of return, up to 8%. But, there is always the risk of the company going bankrupt, and plenty do, especially when the economy tanks. REITs are also much more volatile than bonds, and your actual return may vary from what’s advertised. Beware especially of closed-end REITs. These are REITs that have a finite number of shares, and your money will be locked away for whatever the term length is.
Although REITs may look like a great investment on paper, they’re actually quite complicated and volatile. Before investing in REITs, in a good idea to talk with an experienced financial advisor. They can help you determine what types of investments will help you meet your goals and risk tolerance.
Precious Metals and Cryptocurrency
Some investors believe that precious metals and cryptocurrency are safe from economic disasters and government overreach. They’re often advertised as a way to “hedge against inflation”.
The main benefit of precious metals and cryptocurrencies is that they are not controlled by governments or banks. This makes them a popular investment for those who are skeptical of centralized authority. However, precious metals and cryptocurrencies are also very volatile. Their value can go up and down a lot in a short period of time. Unlike other investments, they don’t pay out interest or dividends, leaving you purely at the mercy of the market. They’re also not very liquid, which means it can be difficult to sell them when you need the money.
Investing in precious metals and/or cryptocurrency is risky. ETFs and floating rate funds may be better options for you.
ETFs (Exchange-Traded Funds)
So, how do you avoid risky investments while still getting a relatively high return? ETFs are one option. An ETF is a collection of stocks, bonds, or other investments that can be bought and sold like a single security. They have become very popular in recent years because they offer investors a lot of diversification for a relatively low price.
One example of an ETF that you’ve probably heard of is the Vanguard S&P 500 ETF (VOO). VOO is made up of stocks from the 500 largest companies in America. When you buy a share of VOO, you get a little piece of every company in the S&P 500. This avoids the default risk that investing in a single company can have. Compared to traditional bond funds, ETFs have virtually no administrative costs, generally perform better, and are considered to be a very safe investment.
An experienced financial advisor can help you pick ETF(s) that match your risk tolerance and will help you meet your retirement goals.
Floating Rate Funds
Floating rate funds are another great alternative to bonds. They are mutual funds that invest in bonds with variable interest rates. The advantage of these funds is that, unlike regular bonds, they will go up in value when interest rates rise.
Floating rate funds offer protection against rising interest rates, which would typically lower the value of a bond. They are also a relatively safe investment since the bonds they invest in are often issued by large, stable companies. However, there are some downsides to floating rate funds. They generally offer a lower rate of return, and tend to have higher fees than other types of mutual funds.
Before investing in a floating rate fund, it’s important to understand the benefits and risks. An experienced financial advisor can help you decide if a floating rate fund is right for you.
Insurance companies are some of the safest investors in the world. They have extremely broad portfolios full of treasury bonds, and other secure investments. Their ability to invest so broadly enables them to eliminate a lot of risks that an individual investor can’t do on their own.
Life insurances companies don’t run the risk of having to pull their investments out early. The average consumer may have a water heater go out in their house, or need a new furnace, and will need to pull money from their investments. Life insurance companies don’t have to worry about that.
So, how can you reap the benefits of a life insurance company’s investment strategy? One option is by purchasing an indexed universal life insurance policy. You’ll get the death benefit that comes with any life insurance policy, along with cash value to use throughout your lifetime. The cash value in an indexed universal life policy grows at a rate that is linked to the performance of an index, like the S&P 500. So, you have the potential to make higher returns than you would with a traditional life insurance policy, at a minimal risk level.
Of course, there are some downsides to investing in an indexed universal life policy. The fees can be high, and you may not have access to your cash value right away. It’s important to understand the terms of the policy before you sign up.
An experienced financial advisor can help you figure out if life insurance is right for you, and what type you should invest in.
What should I invest in?
Each of these investments has its own benefits and drawbacks. If you’re looking to avoid the interest rate risk and default risk associated with bonds, there are plenty of other options out there. We discuss them in great detail on my podcast Your Financial Advocate [LINK]. The experienced financial advocates at DuPont Wealth Solutions can help you decide which investment options are best for you, based on your individual needs, risk tolerance, and goals. Call us at 614-408-0004.