RNP - The Safest Investments In 2022 For Retirees

• We are headed into a period of greater market volatility and economic uncertainty.
• Safe Havens can provide price stability to a portfolio.
• We evaluate 9 traditional safe havens and some picks from the HDO Model Portfolio that match them.

Co-produced with PendragonY

The famous opening lines of Anna Karenina, penned by Leo Tolstoy, say:

Happy families are all alike; every unhappy family is unhappy in its own way.

The idea is happiness is often ubiquitous in many places, but the source or cause of one's unhappiness is as unique as their situation.

When it comes to the market, everyone loves a bull market. No one really questions it or asks why. It just is, and we are happy about it.

When a bear market comes roaring, we naturally analyze it and look for all the causes – each bear market or recession having its own cause as we look for its uniqueness.

There is no doubt that we are entering times when the stock market will be volatile. While some will see this volatility as an opportunity, many will want safer investments to mitigate the impact on their portfolios. This is especially true given the uncertainty of exactly how much the Fed will raise interest rates and the impact that will have on the economy. Investors will look to traditionally lower-risk investments to provide ballast to their portfolios. Let's take a look at 9 safe havens that might provide shelter from volatile stock markets.

Certificates of Deposit

Certificates of Deposit, or CDs, are very safe and FDIC (Federal Deposit Insurance Corporation) insured. They are immune from all market fluctuations as you receive a predetermined interest rate in exchange for locking up your principal for a predetermined amount of time. Each will lock up your money for a length of time with penalties (usually a certain number of months of interest) for early withdrawal. So you have the advantage of being able to quickly access your principal if you need it, but doing so could greatly reduce the interest you receive.

The interest rate on a CD is tied to how long the term is. Longer period CDs have higher interest rates. In recent years, CDs have fallen out of favor as interest rates have been very low. Back in the 70s and 80s, "laddering" CDs was a very common strategy to earn higher interest rates on cash with minimal risk. If the Fed keeps hiking and interest rates keep rising, this might become an attractive strategy again.

CDs are very good choices when you have a date certain when you need the funds and can't take any risk of having less money than you planned. Say you have an obligation like taxes, school tuition, or other major purchase you expect in 12 months, a CD could be a way to ensure your capital is not at risk, but get higher interest than you would get in savings accounts.

As part of a retirement plan, CD rates still seem woefully inadequate, but if rates keep rising that might change. If we see a situation like the '80s where 5-year CD rates were over 10%, then ladder away!

High-Yield Savings Accounts

High-yield savings accounts, like CDs, are FDIC insured so you have no risk of losing your investment principle. With these accounts, you are not locking your money up for a specified amount of time, but for that additional flexibility, you tend to get a lower interest rate.

U.S. Treasury Bonds

Because the U.S. government has never defaulted on its bonds, U.S. Treasuries are one of the safest investments available. With TIPS (Treasury Inflation-Protected Securities), you can get government bonds that have their face value and the interest they pay adjusted for inflation. Because TIPS trades on the open market, their price adjusts to inflation expectations.

The chart above shows the inflation expectations built into the price of 5-year TIPS. Right now, the market is expecting inflation to be around 2.6% per year over the next five years. With inflation running at 8.6% at last report, it could be a very good bet that inflation will be higher than that. If so, that would make the 5-year TIPS a better bet than the 5-year Treasury.

Shorter-duration bonds have lower price volatility in response to interest rate changes and are easier to hold to maturity (and thus ensure the collection of full face value), so they are a good choice here for safety. However, it is worth noting that if interest rates keep going up, prices will fall. The "safety" is only guaranteed if you intend to hold until maturity when you will receive par value.

Either way, all U.S. Treasury securities are a safe investment.

For both TIPS and regular Treasuries, there are also several ETFs that invest in Treasuries (both inflation-protected and regular) for those who don't want to manage the holding of multiple maturities and rates. Since these ETFs are always buying and selling bonds instead of holding to maturity, the price of the ETF will go down as interest rates rise. You don't enjoy the same benefit of knowing you will collect par at maturity.

Buying Treasuries or TIPs directly and holding to maturity can be a great way to earn zero-risk interest. Buying an ETF that holds these is better suited for hedging your portfolio against recession, or speculating that the Fed will cut rates in the future as you will be fully exposed to the price movements of Treasuries.

Agency MBS

We talk a lot about mortgage real estate investment trusts ("mREITs") that invest in "agency MBS." These are bundles of mortgages that are guaranteed by the "agencies," Fannie Mae or Freddie Mac. This means there is very little risk, as Fannie or Freddie will buy the mortgage back at par if it defaults. Agency MBS is generally considered to be second only to U.S. Treasuries in terms of credit risk.

Agency mREITs can be very volatile because they use substantial leverage to profit on the difference between MBS rates and Treasury rates and achieve a very high yield.

What you might not know is that you can invest in agency MBS directly with less risk, but also a lower yield. Going through your brokerage's bond section, you can select "agency/GSE" bonds, and invest in agency MBS that mature anywhere from 3 months to 30 years. Yields are generally higher than for Treasuries of similar terms and you benefit from the "agency guarantee" which ensures you will receive par value if borrowers default. It can be a great safe option to buy and hold until maturity, and the secondary market is reasonably liquid if you wish to trade more actively and take advantage of currently low prices relative to U.S. Treasuries.

Series I Savings Bonds

I-Bonds are another very safe investment opportunity offered by the U.S. Government. Like CDs, there is a penalty for early withdrawal. But giving up the last 3 months of interest is typically lower than the penalty for CDs. And one reason to pull the money before 5 years would be if inflation returned to low levels. So the last 3 months of interest would be quite small in that case. Right now, I-Bonds will pay interest for the next 6 months at a rate of 9.62%. This is composed of a 0% rate that is fixed for the next 30 years and a 9.62% rate that is recalculated based on inflation every 6 months. Investors should also keep in mind that there are yearly maximums that can be put into I-Bonds. The limit is $10,000 per SSN, with another $5,000 available by using one's federal tax refund.

Gold

Gold is seen as the ultimate in safe havens. And it does provide some protection from inflation – just not every year. Timing can make a big difference. At times it can be as volatile as the stock market, but over the long term, it does tend to keep its value. It is a monetary asset, so its best use might be to diversify away from dollar-based investments.

Corporate Bonds

One can invest in corporate bonds rather than Treasuries or MBS to secure higher yields. This will likely also increase risk, as private companies have fewer options to ensure they can pay their bills than governments do. While AAA rate bonds tend to be the safest, research can find other lower-rated but higher-yielding selections that are safe. As with Treasuries, shorter durations will ensure both lower market price volatility from interest rate changes and make it easier to hold until maturity.

Corporate bonds can be illiquid. Trading them can result in high fees. Bond ETFs can help resolve that problem and add additional security through diversification.

Another way to invest in corporate debt without the higher fees often charged by bond dealers is to invest in Baby Bonds. These are bonds, typically of lower face value, that are traded on exchanges just like stocks. And with a face value of $25, or $50, it is easier for investors to put a small amount into a position. Remember, regular bonds have a face value of $1,000 typically.

One example of a good baby bond is:

Entergy Louisiana, 4.875% Collateral Trust Mortgage Bonds Series due 9/1/2066 ( ELC )

Entergy is a large electric utility that operates in the southeast – Louisiana, Texas, Mississippi, and Alabama. Utility bonds tend to be very safe. Adding to that safety is the fact that ELC is a secured bond. A secured bond is backed by collateral for example property owned by the company. Secured bonds rank above unsecured bonds in a bankruptcy adding even more to their safety.

ELC is one of the first baby bonds with an “A” rating by S&P and an “A2” rating from Moody’s. Since the size of the issue is $270 million, which is larger than the typical baby bond issue, this issue is much more liquid and easier to sell should the need arise.

Selling under par, this bond is particularly attractive given its high safety factor. With a 4.875% coupon, its YTM is above 5% at current prices. Much higher yields are achievable with baby bonds, and the HDO portfolio holds several with 7%+ YTMs.

Unlike government bonds and MBS which are guaranteed, corporate bonds can be subject to default risk. So any investment in bonds should be seen through the lens of an investment, complete with due diligence and following up on the company. Since you are higher up in the capital stack, the risk is lower than it is with common equities, and the possible returns are more predictable.

Real Estate

Real Estate investments very much depend on the local environment, but they can be both safe and provide a decent income. Real Estate offers a fairly consistent if slow appreciation in value. A common saying is that they aren't making any more of it.

Real Estate certainly has less price volatility than stocks. But it is far less liquid and comes with additional costs, like maintenance and property taxes. While it is also possible to get financing to help cover the cost of purchase, it still requires significant upfront cash.

Some look at property REITs to get the benefits of owning real estate without all the hassles. This allows a smaller upfront cash commitment and is far easier to manage than owning actual real estate. Liquidity is also typically higher. But this also subjects the investor to more volatility than direct ownership which increases the risks.

Owning shares in publicly-traded REITs offsets many of the risks that come with using the REIT structure rather than direct ownership. While you still have higher volatility, you get the advantages of higher liquidity and professional management. Investing in CEFs (Closed-End Funds) adds diversification to increase safety.

Cohen & Steers REIT & Preferred Income Fund ( RNP ) is a Property REIT CEF run by Cohen & Steers, one of the best CEF managers. RNP yields 7.4%. It uses relatively modest leverage (for a leveraged CEF) of 28%.

Because of low analyst coverage, RNP often trades under the radar. RNP currently trades at a discount of 5%. This makes little sense because RNP is a conservative pick with 50% of its investments allocated to preferred stocks mostly issued by property REITs. While increasing interest rates may push the price of these securities down, the discount does provide some cushion. And the income has been very reliable over the last 5+ years.

Preferred Stocks

Preferred stocks are hybrid investments that have some features in common with both stocks and bonds. You get the ownership stake of stocks, and the potential for appreciation, combined with guaranteed dividend payments similar to the interest payment on bonds.

However, that appreciation potential cuts both ways. You will often see larger swings in market pricing of preferred shares compared to bonds. So why are they safe investments? Because preferred stock dividends are guaranteed in nearly all cases, meaning you’ll get income no matter what the stock is doing. This also makes them a very good fit for our Income Method , as we look for reliable income streams from our holdings.

CEFs offer diversification as additional protection even in the already relatively safe preferred securities space. Preferred shares issued by CEFs have both the benefits of the diversification of the CEFs holdings, and the additional security of the legal limits placed on CEF leverage.

Gabelli Dividend & Income Trust, 4.25% Series K Cumulative Perpetual Preferred Shares ( GDV.PK )

GDV-K is a preferred stock issued by the CEF Gabelli Dividend & Income Trust ( GDV ). CEFs use preferred shares to finance some of the leverage they use. They are limited by law as to how much they can use. This adds to the safety of such an issue.

GDV-K has an “Aa3” credit rating from Moody’s, while this isn't the very highest, it is a very safe rating. And because GDV is a closed-end fund, it has leverage limits of 50%. Currently, GDV lists a leverage of about 13%. It currently trades around $20, well under par. It also has 4 years of call protection. QuantumOnline lists more information here .

Conclusion

At HDO we use the Income Method to generate reliable income streams that we can use to buy more assets that pay us, to pay our expenses in retirement, or some combination of the two. Ordinarily, market volatility is an opportunity to pick up more income-producing assets at a good price. However, we are now entering a period where market volatility is likely to be higher than normal and economic conditions could be rough. So some investors would like to put some of their assets into investments of greater safety.

In this article, we looked at 9 investments that many regard as safe-havens. Each has its benefits and tradeoffs. Depending on your goals and your desires for price stability and income, one or more of them could make sense for an investor's portfolio.

CDs, high-yield savings, Treasuries, MBS, or I-Bonds might be appropriate if you have funds that you want to earn a higher yield or protect from inflation but cannot tolerate any risk of loss. Which one is best, greatly depends on when you need the money, and whether you might need it before maturity.

Gold, corporate bonds, real estate, or preferred shares are all investment options that are often safer than others during recessionary periods. These all carry their own risks but can be a great way to diversify your portfolio or receive a stable income even in difficult times.

Take this income and allow it to enable you to think like the closing lines of Anna Karenina :

... my life now, my whole life apart from anything that can happen to me, every minute of it is no more meaningless, as it was before, but it has the positive meaning of goodness, which I have the power to put into it.

Find the good in every moment or be that good. Your financial house can be in order, allowing you to be a positive force regardless of what life throws your way.

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