A one year certificate of deposit (CD) is currently paying an average rate of 0.85 per cent—not even one per cent. Interestingly, that same CD was paying closer to 6 per cent five years ago. So if you had $100,000 invested in that CD, your return went from $6,000 a year to $850. We all know you cannot live on that kind of income.
To make matters worse, bonds have also been hit hard. The 10-year treasury is paying 1.9 per cent and the 30-year is 3.20 per cent. And while those numbers are poor, the real problem is that when you purchase bonds and interest rates rise, the value of your bond goes down. So you could end up getting a negative return on your “treasury safe haven.”
In general, rates on traditional fixed-income investments have been horrible and aren’t getting any better. But there is light at the end of the tunnel. You just have to look in a different tunnel.
Achieving a higher rate of return on fixed income is always possible, but you must be more flexible than in the past. The traditional fixed-income investments like CDs, money market funds, and bonds are not the place to look for yield. The real place to find higher income is in the “alternative fixed-income” space—lesser known investments that don’t follow the mainstream rules of fixed income, and don’t have all of the same qualities.
They don’t have the same guarantees, the same terms or time frames. Not many know where to look. But, if you do, you can usually get a much higher rate of return.
Keep in mind these investments are not like CDs, they do not carry the guarantees of the FDIC. They come with risk, but they are still fixed-income investments that can provide real value in your portfolio. Before you invest, make sure you understand all of the risks and rewards involved.
Here are a few examples of alternative fixed-income investments:
Institutional Leveraged Senior Secured Floating Rate Investments. When discussing senior floating debt to my clients, I give the example of the construction company that goes to the bank to get a loan to buy a crane. The bank says it will lend the money, but stipulates that their loan must be “senior” to other debtors of the corporation and also “secured” in case of a default. The “floating rate” means the loan has little interest rate duration, which is enviable in this environment.
However, the real value with this type of debt is that it is “leveraged” and can earn a much higher potential return than regular floating-rate investments. Recently, the return has been in the high single digits to low double digits. The key here is finding the right balance of risk and return, but great opportunities do exist.
Non-Public Real Estate Investment Trusts (REITs). These are not the traditional REITs that trade on an exchange. Public REITs are too volatile. Private REITs typically perform steadily and are currently providing mid to high single-digit dividends. Again, do your homework. Some are great, while others are atrocious or too new.
Variable annuities with guaranteed income options. Variable annuities are not necessarily great investments because they tend to act just like expensive mutual funds. The real value comes from the potential income benefit. Most variable annuities currently offer a 5 or 6 per cent guaranteed income for the life of the owner. The beauty of that income is that if the market drives the account up, income can increase, but if the market drives the account down, the income remains constant. In retirement, that is very important.
Each of these alternative fixed-income investments comes with different risks that need to be weighed against your risk tolerance. Do your homework and always think of the long term.
Good luck and happy investing.
This post originally appeared on U.S. News & World Report.
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