A year after the financial markets trashed trillions in retirement savings, it's a great time to take a closer look at your investment risk.
I am about five years away from retirement. Should I be considering repositioning the funds in my portfolio to less risky investments? The value of the portfolio has regained some of its losses. I am thinking that I can keep things more stable by moving to safer investments in my 401(k).
— Janice C., Providence, R.I.
The anniversary of the Panic of 2008 is about as good a time as any to take a fresh look at how much investment risk you feel comfortable with. While there’s really no “one size fits all” approach,” here are some things to keep in mind.
Despite what you may read or hear from many financial advisers, there is no such thing as a “completely safe” investment (except for insured bank deposits). Even rock-solid U.S. Treasuries — backed by the full faith and credit of Uncle Sam — can lose value if interest rates go up. And given the extremely low level of rates today, it seems likely they will head higher at some point over the course of the next decade.
The outlook for stocks is just as murky. After destroying trillions of dollars of retirement savings, the stock market has given back some of those losses in the last six months. But it’s far from clear that those gains will continue. The bull market that began in 1982 and proceeded — with some notable pullbacks — to push prices to record highs was really something of an aberration. The odds are just as good that we may be entering a period more like the 1970s, when stocks rallied and fell sharply several times, only to finish the decade about where they began.
If that happens, five years might not give you enough time to recover from one of those down cycles. That means putting more emphasis on preserving your retirement savings rather them maximizing your chances to make them grow. It doesn’t necessarily mean avoiding stocks altogether — even in the worst of times, many large, well-managed companies make it through the storm without missing a dividend.
Which brings us to another major consideration as you approach retirement: You’ll probably want to shift your emphasis from investment gains to investment income. A lot depends on just how much you’re going to rely on your savings. If your retirement plan includes enough other sources of income — Social Security, private pension, income from part-time work — you can afford to take a little more risk with your investments. If you’re relying on your 401(k) to pay the rent and buy groceries, you’ll have to be a lot more conservative.
Finally, there’s no “right” or “wrong” level of risk. Some people would have a hard time sleeping at night without a guaranteed income from, say, an annuity. Others are willing to take bigger risks — knowing they may have to downsize their cost of living if the gamble doesn’t pay off.
That may be the one good thing that came out of last year’s meltdown. After years of relentless rise in stock and housing prices, we all learned the hard way what market risk is all about.
What are ‘third-party trust instruments,’ and how are they purchased and sold?
— Dick T., Address withheld
A third-party trust is a hybrid investment cooked up over the past decade or so by Wall Street firms looking for one more product to sell.
In this case, the financial wizards bought various forms of corporate debt, packaged it in a trust, and then sold preferred shares in the trust. Like pretty much everything else Wall Street does, this involves taking some money from over here, moving it over there and keeping a little for yourself.
The shares in the trust are assigned a ticker symbol and trade on the New York Stock Exchange. You can buy and sell them like any other listed stock.
So why would you want to bother with these things? The short answer is: They pay a higher yield than you can get from a Treasury bond or a CD.
A share of preferred stock, despite its name, is really more like a bond; you buy them for the income. The name comes from the fact that holders of preferred stock get paid before common stockholders and after bondholders. So the market price of a preferred stock depends heavily on the financial health of the company that issued them. The dividend is fixed, but it isn’t guaranteed.
Third-party trust preferreds are currently paying a nice return, but those higher returns come with higher risk. If the company that issued the debt held in the trust runs into trouble, the market price of the trust preferred holding that debt goes down. But the dividend stays the same. So if you buy riskier trust shares selling for less than the issue price, you’ll get an even higher return.
To illustrate, let’s look at one of these beasts — the “MS Structured Asset SATURNS 2003-13, 6.25 percent Credit Suisse FB USA” (Ticker symbol: DKY).
Translation: Morgan Stanley packaged debt issued by Credit Suisse in August 2003 and issued “Structured Asset Trust Unit Repackagings” — or SATURNS — which pay dividends using the interest that Credit Suisse pays this trust holding its debt. (Wall Street firms that cooked these up also came up with cute acronyms: There are COBALTS, CorTS, PCARS, PPLUS, and TRUCs, etc.)
The Credit Suisse SATURNS sold for $25 a share when they were issued and have paid a dividend of 6.25 percent, or $1.56 (in two installments) every year. The share price held fairly steady for nearly five years. When Wall Street melted a year ago, the market price of these SATURNS fell as low as $13.43.
But they continued to pay the same $1.56 dividend. So if you bought them at $13.43 a share, your annual yield would be 11.6 percent ($1.56 divided by $13.43). Since then, as confidence has come back in Credit Suisse, the shares are back up to $21.30, and the yield for today's buyers has fallen back to 7.3 percent ($1.56 divided by $21.30).
Investors in SATURNS backed by Ford debt haven’t fared as well: originally issued at $25, they fell to $3.47 before recently bouncing back to $16. If your think Ford’s worst days are behind it, you can earn 12.75 percent on your money with these preferred.
Two other points to keep in mind: Because the interest paid into the trust is claimed as a tax deduction by the company paying it, investors who buy these trust preferreds don’t qualify for the 15 percent tax rate on their dividend payments. (That higher tax rate is one reason the dividends are higher.)
Third-party trust preferreds are also usually “callable” five years after the issue date, which means the company that created the trust can buy them back at a set price.
For more on individual preferred issues, check out QuantumOnline.com.
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