History has shown that when most investors are doubtful or fearful,
seeking safety is the wrong thing to do because the fears of these
investors are caused by price declines which have usually already
occurred. Presently, while the critical point of the recent credit
market crisis appears to have passed, many investors are still
in a state of shock and having trouble seeing themselves own any
investment without some sort of guarantee.
Unfortunately, the yields currently provided by investments offering
a decent guarantee are very low. Locking your money away in two-
and three-year CDs will yield less than 3 percent. Even a 10-year
government bond, where yields have been rising lately, only promises
3.6 percent as of the day I write this.
Sales of fixed annuities have gone through the roof in the last
year, as investors clamor for the slightly higher "guarantee" offered
by the issuing life insurance companies. Rates here can approach
4 percent or so, if you are willing to lock up your money for 5
to 10 years Read the fine print, though, because liquidating before
maturity can cause a market value adjustment, which is insurance
company lingo for "you don’t get 4 percent if you need your
money before 10 years."
So let’s take a look at how you can construct your own guarantee
of principal value at a future date. This method does not guarantee
a rate of return, but gives you a reasonable chance to do better
than the guaranteed rates, along with the knowledge that your principal
Here’s how this can work. It’s not really different than a normal
balanced portfolio concept, but because the amounts are structured
specifically to make sure your principal value is returned at some
point in the future, it may be easier to put up with the inevitable
market fluctuations that tend to make us nervous and perhaps bail
out on our investment plan.
Let’s say we have $100,000 to invest and we want to ensure return
of our principle 10 years from now. You can buy $100,000 face value
of U.S. Zero Coupon STRIPS maturing in 2019 for approximately $65,000.
Zero Coupon STRIPS are bonds which don’t pay interest like normal
bonds, but which are bought at less than face value, with the investors
profiting when receiving full face value at maturity. So the $65,000
purchase of STRIPS provides a U.S. government guarantee of you
receiving $100,000 in 2019.
Now, you can take the remaining $35,000 of the $100,000 investment
and purchase a diversified portfolio of common stocks or mutual
funds or hire a professional manager to direct the equity portion
of the account. On the broad assumption that equities provide a
return over the next 10 years equal to their long-term average
of around 10 percent, the $35,000 equity portfolio would grow to
about $90,000. When added to the $100,000 of maturing bond proceeds
in 2019, the total account value would be approximately $190,000
– about a 6.6 percent annualized rate of return.
But, even if the stock portfolio didn’t make any money over the
next 10 years and just ended up breaking even, your account would
still be worth $135,000, representing an annualized rate of return
of 3.05 percent, which is in the same ballpark as the various guaranteed
rates being offered today. And, if the stock market vaporized into
thin air and went to zero, you would still have your principal
of $100,000 from the maturing bonds. By the way, if this last doomsday
scenario came to pass, no insurance company would be surviving
to make good on its guarantee of the fixed annuities you have purchased.
So, this is what I like to call the chicken’s alternative to
the packaged products Wall Street and the insurance companies have
put together to sell you. It represents a good chance to do much
better, a chance of doing about the same and a very slim chance,
in my opinion, of doing worse, but even in that event, you get
your original principal investment back.
The approach can be modified a little further to potentially
earn a higher return by using investment grade corporate bonds,
which don’t offer the same guarantee as the U.S. government bonds,
but have a low incidence of default.
By way of disclosure, we have ignored the possible effects of
taxes, which would apply to all the alternatives above unless the
strategy was used in an IRA or other qualified account. Also, the
rates used in the discussion above fluctuate daily, and the end
result will depend both on the yield of the fixed portion of the
portfolio as well as the returns achieved in the stock portion.
In summary, I believe the next 10 years have a good chance of
providing above average returns on stocks and other investments
where risk is involved – the exact opposite of the last 10 years.
However, I may not turn out to be right. I would rather see someone
invest a minority portion of its portfolio and earn a higher return
by sticking with its plan, knowing at least the principal will
be safe, than to accept the very low returns of absolute guaranteed
investments and then find they are not earning enough to keep up
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing.