TODAY'S WORST INVESTMENT STRATEGY

I've Been Warning About This For Some Time. A common strategy for today's older investors is reaching for yield. Given the risk in the equity markets and less than 1% money market yields it is not surprising that older investors are trying to squeeze higher yields from their fixed income investments than is prudent in this market. Perhaps the worst strategy involves your friendly banker. In addition to the standard mix of certificates of deposits of varying maturities, your banker often has access to other products that offer higher yields. These are often inappropriate for older clients who don't want to take any risk and who might need access to the funds for future health care or other emergency needs. Here are a few strategies I have observed lately along with their implications.

1. Long Term Certificates of Deposit. I recently consulted with a client who bought a $150,000 certificate of deposit with a 2.5% yield. The maturity was five years. Although he has already received one year of benefits, he has four years to go at this yield. If he holds the CD to maturity, he may do considerably better than 1-year certificates or money market accounts; however, if rates go to 4% this year or next, he is stuck with 2.5% for the next 4 years. This isn't the worst case. This client is now faced with very high costs to provide health care for a spouse who has a chronic illness and requires round-the-clock care. Although the income from this and other investments was more than sufficient to fund ordinary income needs, it won't fund health care needs of the spouse. If it becomes necessary to terminate this CD prematurely, the penalty will undoubtedly exceed the interest collected. FDIC insurance provides piece of mind but it won't protect you if you need the money for catastrophic illness.

2. Special Structured CD's. This same client had a type of CD that I had never seen before. It came through a brokerage company owned by the same bank. At first glance, it appeared to be a standared $100,000, federally-insured 3 year CD with a rate of 4%. Doesn't sound too bad; however, there was another feature of which the investor was not aware. The second and third year interest rate of 4% would only be paid if the S&P 500 index was the same or higher than on the day of purchase. If lower, the interest rate for that particular year was zero. That's right the maximum rate was 4% but the minimum rate was zero. The penalty for early withdrawal was higher than a normal bank CD. This investment was entirely inappropriate for the client. Not only that, but the client had no recollection of being thoroughly advised of this adjustment feature.

3. Annuity Products. Although there is a use for annuity products in certain situations, many clients purchased these because of higher initial interest rates without regard to the other terms. For most clients over 70, annuities are inappropriate due to high surrender charges and low liquidity. The client in this example also had a$100,000 annuity. The terms of the annuity allowed it to be surrendered at no fee if the client or spouse went into a long-term care facility; however, since the client preferred home health care for the spouse, this didn't apply. Annuities are often popular with banks because of the high commissions involved but you need to make sure you know what you are aiming at before you pull the trigger.

Beware Your Friendly Banker. Bankers enjoy a higher degree of trust than other financial services personnel; however, they have conflicts of interest just like stockbrokers and some investment advisors. If your banker is recommending a financial product, look closely at whether he is making this recommendation for his benefit or yours.