The great Wayne Gretzky attributed his success to his ability to skate to where the puck was going, instead of where it currently was, like everyone else. If you have a lot of your assets sitting in a money market earning 5%, you are not skating to where the puck is going.
Currently there is over 6.3 trillion* that is currently in money market funds Money market is great in a rising interest rate environment, but interest rates are expected to fall. How do we know this? The bankers of the Federal Reserve who set interest rates told us this in June when they all gave their quarterly opinions of the economy and the projected path of future interest rates.
These opinions are summarized in a “dot plot” which is a chart that summarizes where each Fed official sees interest rates going in the future. According to the dot plot, the fed funds rate will drop from 5.25%
to about 4% next year and about 3% in 2026. There is no guarantee these projections will be accurate but both borrowers and savers need to make projections, and the dot plot is often utilized for that purpose.
Borrowers who refinanced their home, near or below 3% when interest rates were low, possibly made one of the greatest trades of their lives. If you are a lender or investor and you want to skate to where the puck is going, you probably want to lock in interest rates for a long time before they go down.
One way to lock in higher rates for the rest of your life is to invest in a lifetime income stream from an insurance company. According to Barron’s, higher interest rates have boosted guaranteed pension-like income offered by fixed-indexed annuities, which protect principal while tying returns to a stock market index. Current payouts are 25% higher than they were a year ago. Locking in 6.5% guaranteed interest that creates partially nontaxable lifetime income from an insurance company before rates fall could be the next great trade.
Income Investing
When interest rates are high like they are currently, there are some interesting income investments that can produce high levels of income for those who are needing it to fund their retirement which are also very attractive total return investments that can potentially outperform equities with less volatility.
Private credit funds, which are comprised of secured loans made to non-public companies, are currently distributing over 10% per year to investors with very low volatility. Private mortgages,secured by real estate and private mortgage funds, are also distributing over 10% interest with a 20% tax deduction on the income.
For those who are comfortable with a little more risk, funds that make construction loans are yielding 12 to 13%. Alternatively, major banks are offering a variety of income notes, some of which are linked to individual
stocks but also notes linked to major indexes like the S&P 500, Russell 2000, and the Dow Jones, that are yielding around 9%.
One example is a note linked to the aforementioned indexes. Each quarter if none of the indexes are down more than 30% investors make 2.25% that quarter (9% annualized). At the end of the term, typically 4 to 5 years, the bond will mature for its original investment The only way for the investor to lose money is if one of the indexes is down more than 40% from the starting point of 4 or 5 years earlier.
If you look at all the rolling 4-year periods since 1988, the S&P 500 has been 40% lower after four years less than one tenth of one percent of the time. All these income strategies can not only be a great source of income, but the projected returns would all have beaten the S&P 500’s annualized 7.4% return since the year 2000.
However, the Fed is expected to cut rates over the next couple of years, starting this September. This will likely put downward pressure on the strategies that are currently available so it may be advisable to explore these options sooner rather than later.
Unicorn Note
Most investors who invest in the stock market are trying to get returns that hopefully can keep pace with the broad market indexes. If your portfolio beats the S&P 500 (which is the benchmark by which most stock investments are measured) over long periods of time, then you will likely be in the top 10% of all investors
A major US Bank is offering a 5-year note that will grow at twice the returns of the S&P 500 excess return futures index (SPXFP).
Additionally, if the index is down between 1 and 40%, the note will mature with the same percentage gain as the percent drop in the index.
If you invest $100,000 and the index is down 26% at the end of five years your bond will mature for $126,000. Conversely, if the index is up 50% and your note hasn’t been called prior to maturity your $100,000 will be worth $200,000 (50% gain x 200%). After the first year, the bank
has the right to call your note and return your principal for an 18% per year gain. If at the end of five years, the index is down 41% you will lose 41% of your money.
The good news is that the S&P 500 index has been down more than 40% from five years earlier only once out of every 2500 rolling 5-year periods * The S&P 500 futures excess return index is highly correlated to the S&P 500 index. However, it does tend to underperform the index slightly when interest rates are relatively high like they are now.
If interest rates fall as expected the SPXFP will have an even higher correlation to the S&P 500 index than it currently does. When this happens, subsequent notes linked to this index will offer less leverage than is currently available Therefore, if you think interest rates are going to fall, this is a great time to lock in leveraged notes that are linked to this index. Getting double the return of this index is one way to beat the market with less investment risk than direct stock market investing.
7% For Life
As the Federal Reserve has indicated interest rates are expected to drop to 4% next year and 3% the following year. Just like it’s smart to refinance one’s loans before interest rates rise, it is equally smart for income investors to lock in high yields before interest rates go down
One of the ways to lock in higher rates is to purchase a lifetime income stream from an insurance company. According to Barrons, guaranteed lifetime income payouts are 25% higher than they were a year ago.
I have identified an insurance company offering the highest rates by a considerable margin. For example, a 60-year-old female who gives $1 million to this insurance company will get about $88,000 per year for life after one year As this income is distributed, part of it will be treated as return of principal and therefore nontaxable.
Currently married couples who are affluent and have access to good nutrition and medical care have a 50% chance of one spouse living to
age 95. If the 60-year-old annuitant lives to age 81 the total return would be 6.4%. If the annuitant lives to 91 the total return would be equal to 8.2%. Additionally, if the annuitant winds up needing long-term care the income would double to $180,000 for up to five years.
If the annuitant dies relatively early, the remaining account value would go to the contract owner’s beneficiaries The risk of not living that long can be eliminated by purchasing life insurance. For a 60-year-old female in good health, it would cost about $16,000 per year to buy $1million of life insurance. In that case the annuitant would receive $88,000 per year from insurance company A and send $16,000 per year to insurance company B Thus, the net annual lifetime income would be 7.2% per year with the initial $1,000,000 returned tax free to the contract owner’s beneficiaries regardless of what year the death occurs.
By using this strategy, you can create a guaranteed return that is much higher than prevailing interest rates while also addressing potential long-term care needs.
