Seniors Screwed By Fed Policies

by: David Fry

12-20-2012 9-13-51 AM euro screwedIt's just a sad fact -- older investors continue to face a dilemma as they seek conservative investments and yield. ZIRP and QE have forced conservative investors to take risks they wouldn't otherwise take, which might include junk bonds and other low quality investments sporting seductive yields.

The common advice for investors within 5-10 years of retirement is to allocate more assets from the portfolio to conservative investments -- primarily bonds and other income producing assets and away from riskier common stocks. However given ultra-low interest rates, high quality fixed income investments barely exceed the rate of inflation, if at all. Inflation is running at 2%, if you believe the official data, while yields on 10-year Treasury bonds are only just over 1.50%. If investors extend maturity dates on bonds to gain more yield, and interest rates rise, they lose purchasing power, not to mention the unrealized loss of principal on their investment.

The demand for junk bonds has never been greater, and so too is the risk of loss. Junk bonds tend to trade more with stocks than bonds. This is due to the fact that junk bonds are more sensitive to economic conditions. If those deteriorate, the ability of the bonds to service bond debt is more likely to become impaired. Defaults and bankruptcies then increase. With ETFs, there is safety in numbers one would think, but that's a maxim that could backfire if ETF holdings are concentrated in one or two sectors.

Cash and/or bank CDs may be the more appropriate investment. Deposits are insured, and by not extending the maturity beyond five years, yields will be comparable or better than U.S. Treasury bonds or investment grade corporate bonds. Naturally it's more difficult for brokers to place CDs in your "wrap" accounts, but it can be done with a little effort.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.