It’s no secret that today’s low but rising interest rates are bad for bonds. You’re not getting much yield to begin with. To make matters worse, bond prices move in the opposite direction to interest rates, so the value of your bond holdings have been hit hard as rates have started to rise.
But what are the alternatives? Many investors have moved some of their bond holdings to stocks, but you can’t move too much and still maintain a balanced, diversified portfolio. After all, you shouldn’t be overexposed to uncertain stock markets either.
So it might help to consider other categories of investments that can provide relatively steady income and low volatility – similar to the traditional role of bonds – but with less vulnerability to rising interest rates.
Two additional investment categories that can help fill this role in the right circumstances are income properties and annuities. Of course, each comes with its own risks as well as rewards and isn’t for everyone.
There’s no doubt that buying a rental property can provide steady income, but can you still earn a decent return considering today’s high real estate prices?
You can if you go for a relatively overlooked market niche, says Don Campbell, author of Real Estate Investing in Canada.
Mr. Campbell’s advice is to avoid high-priced condos in places such as downtown Toronto and Vancouver and instead buy three- to six-unit multiplexes in smaller centres or on the outskirts of large centres with steady population growth. He likes “under the radar” neighbourhoods in places such as Surrey, B.C., Leduc, Alta., Winnipeg, Hamilton or Halifax.
To be conservative, base your investment decision on the money you make on rents minus all operating and financing expenses and don’t count on capital gains, advises Mr. Campbell, who is co-founder of the Real Estate Investment Network, an educational and research company.
He says if you look carefully you can find properties that earn a 10- or 11-per-cent “cash-on-cash” return, a common real estate financial metric, without too much risk. Cash-on-cash return measures gross rents minus all operating and mortgage costs (principal as well as interest), then expresses that as a percentage of the cash down payment. Mr. Campbell assumes a 25-per-cent cash down payment in his calculations.
To reduce risks from rising interest rates, lock in rates for at least five years and ideally 10 years, then strive to quickly pay down the mortgage, he says. One conservative strategy is to aim to pay off the mortgage by retirement.
Investing in a rental property can potentially give you better yields than bonds, plus the possibility of raising rents to keep pace with inflation. But you have to do your homework and get involved closely in overseeing your property, even if you hire a property manager to do much of the day-to-day work. “It is a small business and you have to manage it,” says Mr. Campbell. If you want a passive real estate investment, stick with REITs and publicly listed real estate companies, he advises.
Another issue for real estate investors to consider is diversification. If your rental property is located in the city where you work and own a home, a lot of your income and wealth depends on the health of the local economy. That can leave you exposed to a regional downturn.
Annuities are specialized products for seniors that ensure you never outlive your money. You give a lump sum of money to an insurance company; in return, you get guaranteed monthly income for life.
Unfortunately, like bonds, annuity payouts on new purchases are affected by low interest rates and are near historical lows. However, unlike bonds, payout rates also increase with the age of the purchaser, so you can get a better rate if you wait a few years after you turn 65 before you buy annuities. You may also benefit if interest rates happen to rise while you wait.
These days the “sweet spot” for buying annuities is some time in your early 70s, say many experts. Jim Otar, a financial planner and retirement researcher at retirementoptimizer.com, says it’s a good strategy to start buying annuities around the time you turn 70 and then add to your investment gradually over about three years. Moshe Milevsky, professor of finance and mathematics at York University, suggests starting at a similar age and doing it over three to five years.
While waiting means you get fewer payments over your remaining life, the experts say delaying your purchases tends to provide a more efficient way to cover off the “longevity risk” of outliving your wealth.
“You should slowly transition,” Mr. Milevsky advises. “You see how comfortable you are with the income you’re receiving. You get used to the idea of that income coming from one of these products. Then by the end of the five years you have completely annuitized the portion of your nest egg that you want to have in annuities.”
Mr. Otar says a good strategy is to invest enough in annuities so that their payouts in combination with government pension income can at least cover non-discretionary basic expenses. “It provides peace of mind because you know the basics are covered no matter what happens in the markets,” he says.
Annuities are best-suited to relatively healthy seniors who are concerned about the risk of outliving their money. They tend to make less sense for seniors who place a high priority on leaving a bequest, or who are in poor health, or who already have their income needs covered by employer and government pensions.
Realize, too, that conventional fixed annuities are vulnerable to inflation that will reduce the “real” purchasing power of fixed payouts over time.
Rob Carrick will return
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