In today’s low interest rate environment retirees and soon-to-be retirees, on fixed income, often try to get more interest and yield in their retirement nest eggs. These investors should be wary when asking their broker or financial advisor to find investments that have higher interest or dividend rates. The compliant broker may look for suitable investments and disclose the risks associated with these recommendations, or even recommend no action however, the unscrupulous broker may easily find higher yielding investments that come with greater risk and volatility which will earn the broker a nice commission. For example, an investor with a decent portfolio of individual bonds may ask his broker for more income. If the broker is nefarious he may recommend a high yielding bond mutual fund, high yield bonds, a real estate investment trust, investment CDs (i.e., structured products — will address in another blog entry), or perhaps an unauthorized private investment opportunity. This broker will seek to earn a nice commission on the purchase, as well as, on the sale of the bond portfolio.
Investments that state “high yield” may also be “junk,” or in other words, less than investment grade (i.e., less than BBB rating. These can be BB, B, CCC or even securities in default). Junk bonds may not be suitable for an investor not willing to accept increased risk or volatility to their retirement nest egg. Another interesting caveat is that while the individual high investment-grade bonds, if held to maturity, will return your face value investment, a bond mutual fund does not mature. A bond mutual may often “turn-over” the underlying individual bonds in it’s portfolio, which is also known as being actively managed. This could affect the net asset value since the bonds in the mutual fund’s portfolio will be bought and sold through out the year.
If a broker is recommending investing into real estate as a replacement to that bond portfolio be wary of the risks associated with that real estate investment. Often these investments can be illiquid and subject to various risks to your original investment, to include a risk of complete loss of your money.
Investors looking to exchange their bond portfolio should be extremely wary if approached by their broker recommending an investment in a security that is accompanied with a prospectus. If a security is sold with a prospectus, it may indicate that the security is new and maybe sold under an exemption of the 1933 Securities Act (i.e., an exempt and unregistered security offering). Such a replacement investment may not be suitable for the retiree investor seeking safety in principal and low risk.