As market uncertainty over rising interest rates increases,
investors are likely to get bombarded with sales pitches about the
wonderful and irrefutable benefits of Real Estate Investment Trusts
(REITs) and floating rate bonds. REITs do have some merits to them,
but I would only put a small portion of my investible assets into
them, and only into liquid, publicly-traded REITs.
The hard pitch will likely come with floating rate bonds, and will
sound something like this:
It's a bond like any other! It will return your principal upon
maturity, but will increase its interest payment if rates rise
It's a sucker's game folks, so be careful.
First, in many cases, the assets backing floating rate bonds tend
to be of far lesser quality than the collateral backing traditional
bonds. Second, the total return of these instruments has been very
close and highly correlated to those of junk bonds - which
historically are more volatile than the stock market as a whole.
Last, many floating rate bonds require a significant rise in
interest rates before the coupon payment increases. Looking for
proof? The US Treasury is planning to issue floating rate bonds in
the first quarter of 2014 because they know investors who have been
rattled by talk of higher interest rates will flock to them. Given
the high deficit levels, I don't see much of a chance of the
Treasury Department and the Federal Reserve allowing a significant
enough rise in interest rates to sharply increase their borrowing
costs. Yes, the market will drive yield a bit higher, but I don't
believe it will be enough to offset the risk of these instruments.
So what should investors do? Well, as always it depends on their
risk appetite. Very conservative investors who believe interest
rates will rise should put their money in a money market fund. Not
because it's safe, but rather because money market rates will also
rise as interest rates rise.
Investors with a more moderate risk tolerance should stick with
. They should look for companies with strong balance sheets and
declining dividend payout ratios.
) are great examples.
Growth-oriented investors should take a close look at
low-volatility small-cap stocks. Although these companies can be
more volatile than the overall market, many pay a reasonable
dividend, have a low correlation to the
(INDEXSP:.INX), and are a great supplement to a large-cap
portfolio. My firm has put together a portfolio of high-quality
small-cap stocks, and one of our favorite names includes
), which just announced second-quarter earnings that handsomely
beat estimates and raised its full year outlook. We also like
Tootsie Roll Industries
), which is benefiting from significant international expansion of
The bottom line: Follow Warren Buffett's advice and invest in what
you know. Don't fall for great sales pitches -- after all, that's
what got people in trouble with the tech bubble, the mortgage
crisis, and just about every other investment disaster I can think
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Gary Goldberg Financial