More investors dipping toes in murky financial waters

August 1, 2011

Judging from my email, it’s not difficult these days to find savers and investors who are questioning the conventional wisdom when it comes to investing their money.

Judging from my email, it’s not difficult these days to find savers and investors who are questioning the conventional wisdom when it comes to investing their money.

With the stock market on an erratic and volatile course that seemingly leads nowhere, and yields on cash investments such as money markets and CDs almost nonexistent, more and more income-seeking investors are breaking the old rules by dipping a toe in waters that they would have considered too risky a few years ago.

Instead of sticking to the philosophy that calls for portfolios laced solely with a careful mix of quality stocks, well-rated bonds, and cash, these hardy souls are venturing into eyebrow-raising investments such as junk bonds, commercial real estate, options like puts and calls, and equities in emerging markets in an effort to improve the anemic and unpredictable returns they’ve been enduring of late. According to one adviser, taking on even a little more risk requires overcoming fear of foreign markets.

Philadelphia business owner Jack Thompson has moved about 15 percent of his portfolio into so-called junk bonds.

“I’m well aware of the perceived risk associated with these bonds,” he says, “but I picked them with the help of my broker and I’m enjoying the healthy returns they’re bringing in. I just don’t think I’m straying too far out of my comfort zone. You can’t just stand by and do nothing in times like these.”

Time to make moves
With domestic stocks muddling around in the doldrums, some financial advisers are now advising income-seeking clients, even conservative investors, to consider alternative investments. According to a report from Russell Investments, an investment management firm based in Seattle, 59 percent of advisors plan to increase their clients’ investments in emerging market stocks. Even real estate is getting a second look with 33 percent of advisers planning to recommend further exposure to real estate investments.

Frank Germack, director of the investment department at Rehmann Financial, a business consulting and wealth management firm with headquarters in Saginaw, Mich., says he has noticed a similar feeling in some of his firm’s clients.

“With an almost zero return on cash investments such as money markets,” he says, “I can understand how some investors focusing on income might want to take a look at potential ways to improve returns, even if it means extending their risk factor a bit.”

Mr. Germack has recommended several possibilities for clients seeking better rates of return, among them are lower-rated corporate bonds.

“These would be bonds rated BBB or lower. However, I would recommend a maximum of 10 percent of one’s portfolio invested in these so-called junk bonds.”

Mr. Germack also mentions international bonds, both government and corporate as possible vehicles for improved income.

“With these bonds, there is also the possibility of price appreciation if the dollar continues to decline,” he says.

Important to diversify
In order to maintain proper diversification, Mr. Germack recommends investing in mutual funds or exchange traded funds (ETFs) rather than attempting to pick out individual bonds.”

For fixed income investors concerned about the effects of inflation, Mr. Germack says he feels that Treasury Inflation Protected Securities (TIPS) bonds are a reasonable choice. While the yield on TIPS is not attractive at present, the return for both the interest and the principal adjusts with inflation so your money is protected even if there is significant inflation. If possible, it’s best to put TIPS in a tax-deferred portfolio.

For more information on TIP,S check the Treasury website: www.savingsbonds.gov/

Of course, no matter how your portfolio is constructed, no matter what it contains, it could suffer a serious setback if the U.S. encounters another financial crisis. One possibility for protecting yourself in the case of another downturn in the market is the use of puts and calls. It takes a little study to understand these tools, but this simple illustration might help:

When you buy a put on a given stock, you have the right to sell that stock at a specific price by a specified date. If you bought a put on, say, General Motors and the market price falls, you could then sell the put for a profit.

A call works in the opposite way. The buyer of a call gets the right to buy the specified stock at a given price. If the price rises, the owner gets to buy the stock at the lower price specified in the call option. If the stock doesn’t go above the option price the call expires and the owner just keeps the stock. For more on how puts and calls work, visit: http://www.ehow.com/how-does_5251749_do-calls-work-stock-market_.html.

Know your comfort zone
Of course, venturing out of one’s financial comfort zone is not for everyone. With so many investors having suffered painful losses over the past few years, any mention of increasing risk is likely to cause a dyspepsia attack. Recent financial crises in Greece, Portugal and other countries have caused many investors to regard ownership of anything beyond our own borders as too disruptive for a good night’s sleep.

Advisers who suggest embracing a little risk point out that looking beyond “conventional” investment strategies should be done with discretion. No one is suggesting that quality U.S. stocks and well-rated bonds should be abandoned. Alternative investments may be getting more attention lately, but maintaining a planned and well diversified portfolio is still the basic building block for a healthy investment portfolio.