What happens when you live responsibly and do the right things, like saving for retirement, accumulate six months of living expenses that are set aside for a rainy day, and stay comfortably within your means – yet you still earn less on your investments than the cost of inflation?
Many conservative investors are learning the cost of holding low-risk investments and bank deposits because in the current environment in which they are not earning a plausible return. You don’t have to look very far back to understand how we arrived at this point.
Fall From Prosperity
In early 2007, the economy was clicking along at about 3.5% annual growth rate with the commercial prime lending rate at 7.25%. Long-term mortgage rates were offered in the 5.5% range and most bank depositors could count on returns between 3.5% and 4.5% for a 1-2 year commitment in a certificate of deposit.
For investors that were in the stock market, the Dow Jones Industrial Average (DJIA) hit an all-time record high on April 7th of that year, closing at 14,164. But later in the summer, the bubble began leaking with the cascading failure of several mortgage warehouse companies, CDO defaults, collapse of the mortgage market, and new home construction freeze. Bear Stearns was the first major investment bank to teeter on failure and later in the Fall of 2008, Lehman Bros. filed the largest bankruptcy in history which is still being sorted out. The DJIA fell more than 3,000 points between September and October, 2008.
In response, the Federal Reserve Bank slashed interest rates on overnight loans to banks by more than 5% during 2007 and 2008 to offer the economy lots of liquidity during the crisis. To encourage stability and ensure that there was not a run on an American bank, the Federal Deposit Insurance Corporation (FDIC) raised depositor insurance levels up to $250,000 (up from $100,000) for any depositor in an interest-bearing account. Later, they offered unlimited deposit insurance on any depositor with a non-interest bearing account.
The results? Tens of thousands of investors fled stocks, bonds and money market funds for the safety of an insured bank deposit account. While earning rates were very low, so was risk. Protecting their principal and escaping the increasing volatile investment market was a higher priority for investors until they could see more stability on Wall Street. Banks became so flush with deposits that many stopped paying interest and some even started charging very large depositors to hold their cash.
Analyzing the Current Financial Landscape
Recent events have not done much to inspire confidence with many investors who were considering a return to Wall Street. With the antics of a divided U.S. federal government fighting for the past year over fiscal and tax policies, and the Euro crisis unfolding from Greece to Ireland, there have been six huge swings in 2011 that wiped out the YTD gains in the DJIA.
So what is a retirement investor to do? For some, similar financial returns could almost be matched ostensibly by burying money under your mattress. Surely there must be alternative investments to surpass the rate of inflation? Well there are, but your choice and return will depend on your appetite for risk and your discipline as an investor.
Here are a few brief suggestions to explore in your hunt for a higher yielding retirement portfolio that will provide a path back to positive earnings for your nest egg. Diversifying any portfolio will lower or at least spread the risk of moving outside of bank deposits, but note that some non-traditional IRA investments may require fees paid to third party companies to administer them.
1. Take another look at equities. While the DJIA has certainly remained volatile, there are dozens of mutual funds that offer interests in a diverse portfolio that are fairly immune to sharp spikes in market value. Typically there are many options to offer different degrees of risk that can be shopped to match your temperament.
2. While municipal bonds are getting worse, many highly-rated corporate bonds should perform better than bank deposits today and may be a good anchor for your portfolio to build from. Corporate profits are soaring and they are borrowing lots of long term money to lock in lower rates. Still they pay more than bank deposits.
3. Real estate? If you know what you are doing, there are many viable rental properties and apartments that face foreclosure due to a valuation problem more than an income problem. Moving your funds into these properties under the auspices of your IRA is permissible and the returns come in the form of monthly rent checks.
4. Become a banker? You can also invest your IRA funds into mortgages, meaning you become the banker for others to finance their residential or commercial property. You really need some expertise to do this but if you’re confident you have it, you can earn good money and manage your risks.
5. Become your own angel capitalist? You can invest your IRA funds into your own business. Hopefully you would be fully aware of and very comfortable with the risk that providing funds to a business to control is possible with the assistance of a third-party administrator who buys shares in your company with your retirement proceeds. Grow your company leveraging your own savings.
These choices are certainly not for everyone, but for anyone who understands the underlying business, they are viable opportunities that can enhance investment returns, maybe exponentially. As with any investment, don’t put money anywhere you don’t understand and don’t have complete confidence in the third party you hire to assist you in its acquisition or management.
Charles Green began working in his parent’s small business at age 8 and attended many “board meetings” around the dinner table. Today he is a recognized small business authority with over 30 years of advising, financing and investing in entrepreneurs.
His experience as a commercial banker, venture capitalist and advisor yielded clients in more than 30 countries. He founded and served as President/CEO of Sunrise Bank of Atlanta. Charles has served as corporate director for several businesses in the U.S., Mexico and Europe including a NASDAQ-listed company, and presently serves as Trustee of Atlanta Medical Center, a $250 million for-profit hospital owned by Tenet Healthcare Systems.
Charles authored several books and articles about business financing including bestselling The SBA Loan Book 3rd Edition (Adams Media) and the forthcoming Get Financing Now (McGraw-Hill) available January, 2012. Charles is the current Director of the Small Business Finance Institute. To find out more, visit SBFI.org.