Ways to get higher returns and limit risk

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Elliot Raphaelson

You cannot obtain high rates of return without risk, and any financial planner who says otherwise is not being truthful.

Following are two risky investments I made that paid off handsomely, along with a couple of options for those who are more risk averse.

At the end of 2008, I purchased preferred stock in a highly rated Florida utility company with a coupon rate of 8 3/4 percent, paid on a quarterly basis. For every $1,000 investment, I receive $87.50 per year.

I did not think that this investment was very risky because the company had a high debt rating, and because the company had a long, unremarkable history in Florida. In addition to receiving a good rate of return, the price of the preferred stock has increased, so if I wanted to sell today, I would receive more back than I invested.

A small part of my bond portfolio is in a Vanguard high-yield corporate bond fund. This investment is certainly not conservative. However, because this type of fund did so poorly in 2008, I felt that investing in it was not risky at the prices prevailing in 2009, when I bought it.

In 2010, the rate of return for this fund, as well as for other fund families in this category, was well over 10 percent. At the end of 2010, I rebalanced my portfolio, so I have reduced my holdings in this fund.

I am not recommending either of these investments now. My point is that there are investment options that can provide high income, but they certainly are not risk-free.

It may not be easy to average 8 percent returns over a 45-year period, but most investors can’t afford to simply accept investment options that return less than 1 percent.

Two more-conservative choices

There are options for conservative investors who are concerned about risk but want to get better returns. Here are two:

Laddering. Conservative investors who want to take minimal risk can obtain higher returns (during a time of rising interest rates) by doing what is known as “laddering” certificates of deposit.

This is how it works: You might purchase five certificates of deposit, each with a different maturity of one through five years.

When your first one-year CD matures, you purchase a five-year CD with the proceeds, obtaining what you expect will be a higher rate of return. When your two-year CD matures, you purchase another five-year CD, and so on.

At the end of five years, all of your CDs will have a rate of return based on a five-year CD rate, and every year a CD will reach maturity.

An index bond fund. Long-term investors who want higher returns with minimum risk should consider Vanguard’s Total Bond Market Index Fund (VBMFX). The average maturity is approximately seven years, so your risk is minimal if you are a long-term investor.

You can gradually invest in it to minimize risk. You will have a diversified portfolio, and income is credited monthly. You can make monthly withdrawals, or choose to reinvest the income.

On a long-term basis, you can expect a higher return than you would obtain with money market funds or CDs. The five-year total return before taxes at the end of 2010 was 5.72 percent.

It is likely that inflation will increase in the future, and accordingly interest rates will increase as well. In this scenario, short-term investors will benefit because they will be able to re-invest at higher interest rates. On the other hand, investors in long-term fixed investments will see the value of their investments fall.

Elliot Raphaelson welcomes your questions and comments at elliotraph@gmail.com.
© 2011 Elliot Raphaelson. Distributed by Tribune Media Services.