Key Takeaways
With inflation and interest rates both on the rise, bonds (and bond funds) can go down in value.
If Inflation is rising faster than expected, TIPS can be a great alternative to bonds.
Annuities, private lending and life insurance can also accomplish many of the things that a bond portfolio does—with less risk of loss and other benefits—when inflation and interest rates are going up.
Whether you’re nearing retirement or just getting nervous about the stock market or looming tax changes, many people are starting to look for ways to “de risk” their portfolios.
For as long as I can remember, bonds have always been the default alternative to stocks, but when we say “bonds” we’re really saying: “Give me safe principal protection, with modest predictable income and less volatility.”
But we’re also seeing inflation rear its ugly head. As inflation causes interest rates to rise, bonds (and bond funds) can go down in value, which can hurt your real-returns even more than stocks can.
So, where can you find safety and predictable income during uncertain times? Staying open-minded about your options will enable you to thrive during times of uncertainty. Here are four strategies that have worked well for many of our clients:
1. TIPS (Treasury Inflation Protected Securities). If Inflation is rising faster than expected, TIPS can be a great alternative to bonds. That’s because the principal of a TIPS automatically increases with inflation. When a TIPS matures, you are paid the adjusted principal or the original principal, whichever is greater. Even better, a TIPS pays interest twice a year, at a fixed rate. The rate is applied to the adjusted principal. Interest payments—like the principal–rise with inflation and fall with deflation.
You can invest in TIPS directly through the U.S. Treasury, or through a mutual fund/ETF. Just note that while TIPS provide some insurance against higher inflation, they can lose value in periods of low inflation or deflation. They can also create some fluctuations in cash flow as payments are dependent on inflation. Read on for more about the pros and cons of using TIPS.
2. Annuities. While lots of misinformation circles around annuities thanks to late night informercials, annuities are simply insurance contracts that provide you with a fixed income stream for your lifetime or for another pre-determined period of time. An annuity can be purchased with a lump sum or via a series of payments. They can begin paying you income immediately, or at a pre-determined date in the future. Annuities are often used to fund retirement since the income stream never runs out and they don’t go down in value.
Like bonds, annuities can be designed as an income stream, or simply as guaranteed principal protection with no risk of loss—and in many cases they are tax deferred. Annuities can be an excellent tool for hedging against stock market volatility, especially when you are coming close to a time-based financial milestone that requires you to draw down from your portfolio—i.e., paying for a wedding, college, house down-payment, retirement. Financial economists call that “sequence risk.”
There are a host of options to consider with annuities. The best way to evaluate your options is through a licensed insurance agent. Read on for more about incorporating annuities into retirement planning.
3. Private Lending. Whether through a partnership, syndication or direct loaning, you can protect your principal by loaning money to a wide range of real estate players including investors in apartment complexes, home flippers, self-storage complexes, student housing, etc. The key is that like a bank, you protect your principal by having the borrower collateralize their real estate assets or require them to do a personal guarantee. As a result, the income stream (which is collateralized by the borrower’s assets) is derived from the regular interest they’re paying you to borrow your money. Before jumping in to the private lending pool, make sure you conduct proper due diligence on the real estate operators you’re financing and have legal documents in place that clearly specify the loan terms.
4. Permanent Life Insurance. Permanent life protects principal and is a good storehouse of wealth. It helps you secure an asset on a permanent basis that your family will keep—and it also protects your other assets. Over long periods of time, permanent life insurance will provide a return that’s similar to what you get from bonds. However, that return is tax-advantaged and it also provides a death benefit that can provide a legacy for your family.
Conclusion
Most think of life insurance as a vehicle for protecting your family in the event of an untimely death. However, a properly designed permanent life policy can be a great place to store wealth. It not only provides a tax-free benefit in the event of a premature death, but the cash value that grows within the policy is protected from loss and taxes. Even better, you can tap any time for making large purchases and investments. Finally, many permanent life policies allow the holders to use the death benefit while alive to fund long-term care or treatment of terminal illnesses. For more about permanent life, see my article How to Make Life Insurance an Asset, Not Just a Bill.
If you or someone close to you has concerns about protecting principal during an inflationary, rising rate environment, please don’t hesitate to contact me to schedule a Discovery Session.
Also, come join our private Facebook group to connect with others looking to gain control over their finances https://www.facebook.com/groups/UnconventionalFinancialWisdom/
Prosperity is within your control.
