Here are 3 ways to get better returns than bonds, with some safety
Despite the recent spike in bond yields, some alternative investments offer much better returns with varying degrees of safety.
They include Treasury savings bonds, annuities guaranteed for several years by insurers and, for investors willing to take more risk, interval funds that invest in credit instruments.
The purpose of bonds is to balance the stocks in your portfolio. That’s why we don’t include dividend-paying stocks, which tend to dip when your stocks head south, providing no ballast at all.
In contrast, savings bonds and most multi-year guaranteed annuities should emerge from a recession with barely a ripple. Interval funds will be hit when the economy contracts, but still tend to be less volatile than stocks.
Here are three higher yielding investments to think about instead of bonds:
Series I Treasury Savings Bonds. For true risk averse, these bonds are government backed and as safe as possible. They currently pay 7.12% because their rates are linked to inflation. The rate is adjusted every six months – in May and November – and probably won’t persist, but they’re still a great investment right now.
Indeed, the biggest problem with I bonds is that the government limits you to $10,000 per year. You can buy them electronically from Treasury Direct.
I bonds come with restrictions. You can’t touch your money for a year after buying one. For the first five years, you’ll pay a three-month interest penalty to mine your money. After that, there are no penalties.
Current interest rates make this a bargain even if you need to access the money before the five years are up.
“Even if you lose three months of interest, you’re still doing better than with other investments,” says Michael Finke, professor of wealth management at the American College of Financial Services.
The interest you receive from I bonds is subject to federal tax, but not state and local taxes, which makes them doubly attractive in high-tax places like New York or California.
Multi-year guaranteed annuities.They are the equivalent of bank certificates of deposit, except that they are sold by insurers. As of Friday morning, you could get a 5-year MYGA from an A-rated insurer with a yield of up to 3.15%. In contrast, a 5-year Treasury yielded 2.532% and most bank CDs pay much more than that. A similar 3-year MYGA is yielding up to 2.65%, but has become less attractive in recent weeks as the yield on a 3-year Treasury bond has climbed to 2.501%.
MYGAs are not backed by the US government like a bank CD. However, they are backed by state insurance guarantee funds. Even if the insurer that sold you the MYGA goes bankrupt, which is a rare event, you will get your capital back even if you can get reduced interest. “As long as you’re within the government guarantee limit, there’s virtually no credit risk,” says Larry Swedroe, director of research at Buckingham Strategic Wealth.
Different states have different limits and can be found on the National Organization of Life and Health Insurance Guarantee Associations website.
If you want to invest more than the state limit where you live, you can buy MYGAs from multiple carriers to stay within the limit, says insurance agent Stan Haithcock, who calls himself “Stan the Annuity Man “. Its website gives nationwide MYGA quotes along with the credit ratings of the insurer that offers them. Despite state guarantees, to save yourself trouble, you want to buy MYGAs from financially strong insurers.
You may be able to get even higher interest rates by buying longer term MYGAs. But many financial experts advise against it. If rates continue to rise, you will be locked into a lower rate.
MYGAs come with a potential tax advantage. You don’t have to pay tax on the interest they pay until you withdraw the money, which means you can carry it forward tax-free. Say you buy a MYGA at age 63 while still working and in a high tax bracket. You can wait until you are retired and in a lower bracket to withdraw the money.
Unlike treasury bills, MYGAs are not liquid. There are often steep redemption penalties, sometimes 8% or 9%, if you want all your money before it’s due, Haithcock says. “Some of the redemption fees are predatory,” he says.
Interval funds. For those who want to hold riskier assets, consider interval funds that invest in credit instruments. Many pay returns of 7% to 10%, equity-like returns with less volatility than stocks.
They are called interval funds because they invest in illiquid assets and you can only access your money on a quarterly basis. And even then, funds are generally required to repurchase at least 5% of their shares each quarter. This means that if a group of investors want their money at once, they may only get part of it and have to wait for the rest.
Different interval funds target different corners of the credit market. The $6.2 billion Cliffwater Corporate Lending Fund (ticker: CCLFX) returned 7.3% at the end of the year. It invests in private loans to middle market companies. The fund is sold only through investment advisers and other institutions.
He is only 2 and a half years old. It lost 2.15% in March 2020 at the start of the pandemic, says Brian Rhone, managing director of Cliffwater. It didn’t exist during the 2007-09 recession, but Cliffwater constructed an index of similar loans and it calculates that it would have fallen 6.5% in 2008 and increased 13.2% in 2009. That’s a decent amount of volatility, but much less than stocks. The S&P 500 stock index posted a negative return of 37% in 2008 and a return of 26.5% in 2009.
Other interval funds pursue higher risk strategies and do not offer the same portfolio stability as bonds. The $2.9 billion Pimco Flexible Credit Income Fund (PFLEX) can buy any type of debt, including residential loans and emerging market debt. In terms of risk, “I would say it’s between bonds and stocks,” says Christian Clayton, executive vice president of Pimco.
The fund has posted an average return of 6.3% since its inception in 2017. But that included a decline of around 20% in March 2020 as the pandemic shrunk the economy.
But due to the interval fund’s structure, investors were only able to access their money in May 2020, when the fund recouped nearly half of its losses. “In March, the fund was able to go on the offensive and buy assets at depressed prices since investors couldn’t redeem,” Clayton said.
Write to [email protected]