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A Place to Find Some Return, but with Greater Safety than Stocks

A Place to Find Some Return, but with Greater Safety than Stocks

| July 28, 2020

No surprise to you, but the world seems to be changing faster now than ever.

The COVID crisis devastated people's lives and livelihoods, and left many wondering what's next?

Fortunately, the Federal Reserve and our government have stepped up with large bailout programs. So far, they have helped keep food on people's tables and  aided in the the stock market’s recovery.

Only time will tell whether the negatives of the virus epidemic outweigh the positives of the economic bailout. We've heard strong opinions in both directions, but I urge humility in your predictions.

Currently, some indications suggest we will come out of this terrible situation at some point, whether that be with a vaccine, social distancing, or some other reason.

One of the side effects has been that interest rates have moved to almost zero, much like other developed markets. Until recently, we experienced a dramatic flow of foreign investment into our economy due to comparatively high-interest rates. Now the dollar is starting to weaken as demand wains.

Now, it’s great if you have debt for your business or investment properties, or even your mortgage. Your rates are probably the lowest that they've been in history! But what if you need to get a good, safe yield on some of your cash? The best FDIC-insured money markets I can find are paying a paltry 1%. Plus, that's taxable, so you might only get a .60% net-of-tax yield.

Taxable and tax-free bonds are a little bit better, but with yields as low as 0.5% to 3% - not  much to write home about.

We believe investors need a safety-cushion in their portfolio – a ballast for when the markets get rough. Safe investments help ensure that food still gets put on the table, while avoiding the angst of selling stocks at depressed prices. This belief was reaffirmed again when we saw a scary sudden drop of 35% from late mid-February to late March.

It's irresponsible to have all of your money at risk of a 50% or greater decline if you may need the money soon. Strategically investing perhaps five to twenty years worth of spending-money in relatively safe investments compared to stocks gives you the balance needed to endure poor periods.

Below are three questions you may have. The “what-ifs” as it were:

1) But what if the safe stuff doesn't pay anything?

2) What if inflation means your purchasing power on your safe assets are actually eroding?

3) What if you don't want to put your safe money into junk bonds that ultimately perform just as badly as stocks in downturns?

Well, there ideas are other options, and we call them alternatives investments

This is a much-discussed segment in the investment universe within the financial community, but not often discussed among traditional investors.

We've used alternatives for over ten yearsto try to provide a different, and hopefully, better returns than bonds with less downside-riskthan stocks.

Alternatives, as we think of them at ISC, tend to have less risk than the stock market, but more risk than bonds.

While not always true in every period, we tend to see the return of alternatives to be somewhere between that of stocks and bonds. Lately, however, alternatives have outperformed because of recent downside protection. Certainly the protection helped during the volatility of February and March 2020, but alternative investments also shined in late 2018 when stocks fell 20%.

The downside of alternatives is they can lose money in two main ways:

  1. If the market is down, they can still lose a significant amount, just generally less than stocks.
  2. If the market is up a lot, they tend not to return as much as stocks, so you can have an opportunity cost similar to holding bonds and cash.

It's times like these where we see increased demand from our clients for investments with downside protection. Still, after we have a big shock to the system, there's probably a lesser chance that we're going to have another big drop.

So after a traumatic drop, if we go too heavy into risk-off holdings because they sound so attractive, we risk setting ourselves up for some disappointing results.

Nevertheless, I think there is a place for alternatives in many portfolios.

If you are interested in exploring alternative investments for the“safer” part of your portfolio, please let us know.

Thanks for taking a look!


Your Team at ISC Financial Advisors