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MAKING CENTS OUT OF THE NEWS
Blog #6
(February 5th, 2009)
ONLY SO MUCH JUICE IN THE ORANGE
By Tom McAllister, CFP™
The latest in the Scoundrels and Thieves department (in my January 22 blog I discussed three individuals who managed to swindle lots of money from unsuspecting investors) is that Mr. Nadel of Sarasota, Florida, charged with investment fraud by the U.S. government, has turned himself in to the FBI. Mr. Schrenker of Fishers, Indiana, is in custody in Florida under charges related to insurance fraud and endangering lives in an attempt to fake his own death. In New York, Mr. Madoff remains on house arrest while his tangled Ponzi scheme is being sorted out.
Comic strip character Maxine ("Crabby Road") says "Everything happens for a reason. The reason is usually that somebody screwed up." Obviously these three scoundrel-thieves "screwed up", since they've all been caught! What's more important, I think, is reviewing their stories to see how we can avoid becoming victims of others of their ilk.
In each instance, potential investors were told they would reap superior results, and were asked to "trust" the swindler-in-advisor's-clothing. The word "guaranteed" (use of this word is specifically forbidden by securities regulators in virtually all investments) served as a further lure to naïve investors.
Taking a step back from these sensational but all-too-true tales, let's review what investment returns may be reasonably expected given the various options available. To begin with, low risk investments and double-digit returns are an oxymoron - in real life, over the long term, the two can't coexist.
Treasury bills: Standard examples of a "no-risk" investment are U.S. government treasury bills. Short-term debt instruments issued every week with maturities of three months, six months, and one year, treasury bills are very liquid and can be sold on any business day. Returns on such instruments reflect their low risk; these days, treasury bills are yielding 1% or less. Longer-term U.S. government bonds (with maturities of ten years or more) have traditionally offered 3% above inflation. These bonds carry interest rate risks if sold before maturity.
Bank-issued Certificates of Deposit: CD's have maturities of 90 days to five years or more, and like treasury bills, are guaranteed as to principal and accrued interest by the U.S. Government. The guarantee is now limited to $250,000 per bank per investor. There are "penalties for early withdrawal", meaning CDs are not liquid. Current yields on longer-term (3 years or longer) CDs can be found as high as 4%. I must point out that this interest is fully income taxable to individual investors.
Junk bonds: At the other end of the fixed income spectrum are so-called "junk" bonds. These are rated "less than investment grade" by recognized bond-rating companies such as Standard and Poor's. The reason for the low ratings is the relatively high probability that the promised interest and principal payments will not be met. During these tumultuous times, junk bonds are paying interest in the mid-teens.
Equity investments in common stock and real estate: Long term yields on equity investments have traditionally exceeded the inflation rate by 7%. However, as recent months have proven, the road to this seven percent-plus can be rocky, indeed. Losses of 20-40% have alternated with gains of 20%. In the case of real estate, which is normally leveraged (meaning borrowed funds are utilized along with investor equity to acquire property), both gains and losses are magnified, leading to additional risk.
Investors must make their own determinations as to how much risk they are willing - or able - to assume. But, to avoid being lured into scoundrel-and-thief territory, keep this simple truth in mind when contemplating expected investment returns: Whether it's stocks, bond, or real estate investing, and whether we're talking about navel, mandarin, or Valencia - there's only so much juice in an orange!
With all the rapid changes in our economy and in the investment markets, there are many investors who would benefit from more consistent guidance. We are currently accepting new financial planning and investment clients, and would appreciate your referrals.
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