As investors reel from volatility in the public equities markets – due to factors like inflation, recession fears, war, oil prices, or whatever market driver is trending on a particular day – many are turning their focus on fixed-income investment options.
As an alternative to stocks, investors are attracted to fixed income options for shelter from broader market volatility and as a source of passive income to compensate for any job loss or reduction.
Although there are many fixed income options, not all are created equal. There are pros and cons to consider for each one, but we have narrowed down the most common options for this comparison’s sake.
CDs / Money Market / High Yield Savings Accounts.
Certificate of deposits (CDs), money market accounts (MMAs), and high yield savings accounts (HYSAs) are interest-bearing accounts offered by banks, credit unions, and other financial institutions. They are basically different sides to the same coin, differing principally by interest rates, minimum deposit, balance amounts, and liquidity.
Regarding minimum deposit and ongoing balance amounts, CDs and MMAs are typically on par with each other and generally are higher than HYSAs. Regarding liquidity, HYSAs are the most liquid – typically with unlimited access – followed by MMAs (typically up to six times a month) and CDs (untouchable for a fixed period of months or years). In terms of rates, CD offers the highest rates, followed by MMAs and HYSAs, which provide comparable rates.
PROS:
Secure and Convenient. Because the FDIC insures deposits, these investments are virtually risk-free. They are also widely accessible with few qualification requirements for opening an account.
CONS:
Low returns. According to NerdWallet, the best rate listed right now on a CD with a fixed 5-year term is 3.21%. The best rate listed for MMAs is 1.17%. The best rate listed for HYSAs is 1.21%. The problem with these traditional deposit accounts is the yields fail to keep pace with inflation. In March, the annual inflation rate hit 8.5%, the highest in 40 years. At that rate, in the best scenario (the 5-year CD), your portfolio is eroding at a rate of 5.29% per year.
Corporate Bonds – Treasuries (Bonds and Notes).
Corporate Bonds are fixed note securities offered by corporations, while the U.S. treasury offers treasuries (bonds and notes). The only difference between treasury bonds and treasury notes beside their rates is their length until maturity. Treasury notes mature more than a year but not more than ten years from their issue date. Bonds mature more than ten years from their issue date.
PROS:
Low Risk. Treasuries are considered risk-free – backed by the full faith and credit of the U.S. treasury. Corporate bonds are considered riskier than treasuries because they’re only as good as the company backing them. As a company goes bankrupt, so go the payment obligations on its bonds. In terms of access, anybody can invest in either option. They are considered reliable hedges against stock market volatility in terms of stability.
CONS:
Low returns. The best corporate bond rates currently top out at around 4.0%. As for treasury notes, the 10-year yield currently sits around 3.0%. Once again, corporate and treasury options are losing investments when factoring in inflation.
Annuities.
An annuity is an insurance contract in which you pay a premium to receive regular payments for a specified period. It can be used to fund your retirement so that you don’t outlive your savings. Your annuity rate is the percentage by which your annuity grows each year. An annuity is a product sold by an insurance company where you make a lump-sum payment in exchange for a guaranteed income stream. Current average fixed annuity rates range between 2.70% and 4.30%, with terms ranging between 2 years and ten years in length.
PROS:
Backed by established companies with a history of profitability.
CONS:
Low Rates and Not Transferable. Besides the low rates offered by annuities, the other problem is you may not live long enough to recover your contribution. Because annuities are only effective during the holder’s life, they are not transferable to heirs.
Private Lending.
Private lending is an active investment whereby the lender offers capital to a borrower at a fixed rate and a term of years. As the lender, you do everything from underwriting and originating the loan to servicing and collections. Private lenders typically focus on real estate where a tangible asset can secure their investment. Short-term private lending in the real estate space (i.e., hard money lending) is a common form of private lending.
PROS:
Above-average returns. According to bankrate.com, hard money loan rates can fall between 7 percent and 15 percent but can often be higher depending on the lender.
CONS:
Secured private lending becomes costly when a deal goes south since foreclosing on the property is time-consuming and expensive with significant legal expenses. Plus, if you lend in borrower-friendly states like New York, foreclosure can take years, which leaves you with a non-performing investment longer than you signed up for.
Private Fund – Unsecured and Secured.
A debt investment in a private fund in the business of commercial real estate investing or private lending allows investors to receive a fixed income from a tangible asset without spending the time and effort vetting the investments. In the hands of an experienced, skilled, and proven team, a debt investment in a private fund offers the potential to achieve above-market returns at reduced risk. In today’s market, these investments are sought by HNW investors to preserve their capital.
With a debt investment, the principal is typically well protected in a real asset. A tangible investment with intrinsic value like real estate. These investments are less volatile and are the preferred choice of the savvy investor.
PROS:
Above-market returns uncorrelated to Wall Street volatility. Hands-off investment. Transparent – ability to interact with management. Additionally, secured debt is backed by the company’s assets and prioritizes the investor over all unsecured creditors.
CONS:
Illiquid is not often a disqualifying factor for HNW investors. Investors may be required to meet accredited investor eligibility requirements. An unsecured debt drops the investor in the pool of general unsecured creditors in terms of priority in a liquidation. Secured, private funds are the best option.
Fixed income investments are popular with wealthy investors because the right ones help preserve their principal investment and are less volatile than Wall Street.
Ask us about our Income Fund, secured and invested in a recession-resistant asset class.
