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The stock market has done better than expected during the pandemic. You have cautioned clients “No tree grows to the sky” and the importance of asset allocation. The think fixed income sounds boring. They found other ideas on late night TV or suggestions from friends. They are running them past you. You agree diversification is good, but want them to go into situations with their eyes open.
1. Foreign debt. Your client has heard about bonds in different countries paying rates they only dream about. Sometimes the bonds are issued by governments. What could be safer than that?
Things to know: Interest rates are a reflection of risk. Put another way, there’s a reason the rate is high. These securities are often sold over the counter. Assuming your client isn’t holding it to maturity, they need firms making a competitive market at the time they want to sell. Companies and even countries walk away from their debt. There’s currency risk to consider.
You might: Do some research. Does your firm have an approved fund investing in overseas debt?
2. Offshore banks. Your client finds a Caribbean bank offering rates “too good to be true.” It’s a bank, right? Their deposit is even denominated in dollars. What could possibly go wrong?
Things to know: How quickly we forget! Every few years there’s a scandal. One of these “banks” isn’t as solvent as you thought or is an outright fraud. US bank deposits are considered safe because of FDIC insurance. Foreign banks don’t have the same protection from the US government.
You might: Look at CDs offered by your firm, perhaps through banks around the country. They should carry FDIC insurance. The rates might be higher than the client’s local bank.
3. Currencies. Banks in different countries usually have deposit accounts paying interest. Think savings accounts and CDs. Many stable governments issue short term bonds. The interest rate might be low, but if the dollar weaking and their currency strengthens, you can make money on the exchange rate.
Things to know: You can’t accurately predict the exchange rate movement. They can be affected by world events, since the US dollar is considered the world’s reserve currency. The government where you are earning the interest might think you should be paying them taxes on your interest. This reduces your return.
You might: Look to see if your firm allows clients to hold funds in another currency, offers a basket of foreign denominated short term bonds or uses the strategy above in a fund format.
4. Gold. It’s considered a hedge against inflation. Your client has seen these great ads on late night TV touting the virtues of buying gold coins. What could possibly go wrong?
Things to know: You can make a good case why gold deserves a place in their portfolio. Taking delivery of gold involves storage. Buying gold coins raises the question of what’s the markup on the coins and the purity of the gold?
You might: See if your firm has approved ETFs allowing you to “own gold as a listed security.”
5. Private equity. You read about firms putting money into helicopter ambulance services or veterinary hospitals. The idea sounds brilliant! You wonder “Why hadn’t I thought of that?” Clients wonder how they can get in on the action.
Things to know: Liquidity is often an issue. They expect you to place your money long term. There are many private equity firms. You can research relative performance.
You might: Look at private equity funds available through your firm. They likely have high suitability requirements and high fees, but they should have gone through your firm’s compliance review.
6. Rental property. It’s like a bond, often called income producing real estate. There’s always a need, especially when people get priced out of the home buying market or mortgages are difficult to get. It’s income you collect. A management company can deal with the day to day issues like repairs.
Things to know: It makes sense provided you have good long term tenants that pay rent on time. When a property is empty, you still need to pay the mortgage, insurance and property taxes. Municipal bonds don’t call with a reason why the rent will be late. Tenants do.
You might: Look at listed REITs focusing on residential property.
7. Real Estate. You see lots of TV programs about house flipping. The returns always seem to be great. They sell almost immediately. What could be easier?
Things to know: Real estate has liquidity issues. Unlike a stock, you can’t sell it and get cash three days later. You have carrying charges. If a property is unoccupied because you are intending to sell it, it isn’t generating income. Real estate doesn’t trade on a listed exchange. The price is negotiated between buyer and seller.
You might: Investigate if there are listed firms, followed by your firm’s research that buy and sell property as their business.
8. Art, wine, antiques. Antiques Roadshow is very entertaining. People wonder if they have treasures in their attics. Art often makes headlines, especially the prices contemporary art can achieve. These items are fun to own.
Things to know: The best of the best are the pieces that get the best prices. Condition must be perfect. Even small amounts of damage cause the value to plummet. Prior ownership or provenance is a serious issue. How does the buyer know the piece wasn’t stolen? Auction house commissions are usually much higher than brokerage commissions.
You might: Research investment funds in this area. You want to be sure it’s been through your firm’s compliance review process.
Your client can invest their money as they choose. It’s their money. One of the ways you add value is by trying to prevent them from making a serious mistake. You are an investment professional. In most cases, they are not.