What To Buy Instead Of Bond Funds

¹²What To Buy Instead Of Bond Funds
Less-Risky Alternatives For A High-Risk Market

By Robert Powell, Marketwatch | 6 September 2010

BOSTON (MarketWatch)— Don't lose money. That's frequently the main investment objective of the wealthy. Well, today, ordinary investors— given the current state of the stock and housing market— have much the same idea.

The problem is that they are pouring their money into the perceived safety of bond funds, thinking this will help them avoid losing money. Unfortunately, that's the not case. Bond funds don't offer any principal protection. Any increase in interest rates will send the value of bond funds— not to mention the mood of many investors— downward.

Doomsday Investing

Investor Peter Schiff invests as if the U.S. economy will collapse, which involves moving money offshore, a move he calls the most patriotic way for an American to invest. [[But which carries its own decided risk, as most recently illustrated during the 2008 crash…: normxxx]]Dow Jones Newswires' Meena Thiruvengadam reports on a man who has become a financial fortune teller for Tea Party activists and who predicts an evisceration of the American dream. "I do worry when investment-class money flows move in one direction, such as they are with bonds," said Dave Caruso, the chairman and CEO of Coastal Capital Group. "The problem we have today is the incredible volatility and historically low interest rates have not only scared investors, but left them with no place else to turn for short-term, income-generating vehicles."

Others agree. "Today's markets provide investors few good choices for 'risk-free' investments, especially if we consider longer-term principal protection after inflation," said Chris Brightman, a strategist with Research Affiliates. Indeed, the old standbys— Treasurys, certificates of deposit, insured annuities, savings bonds, and money market funds— aren't of much use nowadays. But that's not to say that there aren't any alternatives. Here's what experts say:

The Laundry List

Caruso suggests alternatives that are mostly traditional. These include: Treasury Inflation Protected Securities (TIPS) with stated maturities; floating-rate funds that are collateralized, but move up and down in price with the current interest-rate environment; long/short (market neutral?) mutual funds or hedged mutual funds that are designed[!?!] to give 'stock-like' returns but with 'bond-like' risk; high quality real estate investment trusts, but only if you do your homework, income-oriented real estate partnerships, though liquidity is extremely low, and MLPs[1]. Read about the risks of floating-rate bond funds.

Caruso is also fond of high-quality dividend paying stocks [[as am I, including selected preferreds (especially those that are convertible at some point): normxxx]]. It's possible to build a portfolio of large companies with good ratings and brand-name recognition that has a dividend yield of 3.8%, he said. [[Or, even better.: normxxx]] Caruso is also fond of master limited partnerships (MLPs), which tend to have high dividend yields and are usually associated with the energy sector. Just beware, he says of yields that are too high, since "many times they give back return of principal intermittently."

Guaranteed Products

For those who are completely spooked by the ups and downs of the market, Christian Weller, a senior fellow at the Center for American Progress, an associate professor at the University of Massachusetts Boston, and author of a forthcoming book "Retirement Security in the Great Recession," recommended other investments and insurance products with principal protection built in [[but only as safe as the viability of the issuers and the product: normxxx]]. These include guaranteed investment contracts, which are essentially financing products for insurance companies. "The interest rate fluctuates, but the principal stays relatively constant," he said. "There is risk, though, in the form of life insurance companies failing. The recent debacle at AIG has illustrated this risk very poignantly. Principal protection does not necessarily mean no risk."

Diversify

Diversification is not so much an investment but a strategy. You allocate assets according to your time horizon, aversion to risk and investment objective(s), and rebalance on a regular if not automated basis. "One of the problems we have seen is that people panic and then move their money exactly in the wrong direction, for example abandoning stocks after a stock market crash or putting all their money into bond funds after a drop in interest rates," Weller said.

Regular rebalancing of a portfolio can be automated through most investment websites and can insulate an investor, at least in part, from the ups and downs of financial markets, he added. "Diversify broadly into a host of asset classes that can offer both reasonable yields and opportunities to excel in different inflationary regimes such as emerging market bonds, bank loans, high yield bonds, commodities and TIPS," Research Affiliates' Brightman noted.

Gold

Gold doesn't provide interest income, nor will it protect your principal in the traditional sense. Moreover, the price of gold is up 30% over the past year and 180% over the past five years. But that doesn't concern Brian Lucey, a professor at Trinity College in Dublin, Ireland nor Dirk Baur, a professor at Dublin City University, also in Dublin. The authors of "Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds, and Gold" say the precious metal is still a safe bet.

"Although I am not an investment advisor, my personal perspective is that there is still good value for long-term investors in gold, if they are risk-averse," Lucey wrote in an email. Baur concurred that gold is worth considering, but, he said, "only in times of market stress or crisis." Which, safe to say, is the investment climate we are in.

Robert Powell has been a journalist covering personal finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times, and Mutual Fund Market News.