The prospect of several more years of extremely low interest rates is causing people who depend on interest income to accept Wall Street’s recommendations to purchase relatively illiquid and opaque alternative investments like structured products, non-traded REITs, hedge funds and variable annuities. (“Itchy Investors Ramp Up the Risk,” Wall Street Journal). Regulators worry that the increased risks associated with such investments are not being explained to investors.
Interest income is down nearly one-third from peak levels in the third quarter of 2008, according to the article. Four-year certificates of deposit are paying an average of 0.88 per cent while inflation is about 2 percent. The last prolonged period of low interest rates occurred 60 to 70 years ago when one-month Treasury bills paid 0.7 percent versus a 5.9 percent inflation rate, according to the article.
Stock market volatility is also subject to extreme levels. In 2011, stocks finished the year “relatively flat” after gyrating wildly. In May 2009, the “flash crash” churned investors’ stomachs the Dow lost 1,000 points in minutes.
The wizards of Wall Street continue to churn out structured products, hedge funds, exchange traded products and other alternative investments to enable investors to chase yield despite warnings from the Financial Industry Regulatory Authority (FINRA) that they should not encourage investors to chase yield because of the risks involved.
Individual investors chasing yield are not the only ones who could get burned. Low interest rates are also “pressuring life insurance companies” to chase yield and some life insurers may be taking on more risk than they should.
All investors should remember that increased yields invariably mean increased risk. There simply is no free lunch.
Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.