November 8, 2012
The Wall Street Journal
The Federal Reserve is keeping short-term interest rates at near zero levels and very few foreign central banks have interest rates much above 1%. Finding themselves in a challenging environment in which to derive income from their stocks and bonds, many retirees think they’ve found a solution in the form of high-yield investments such as real-estate investment trusts. But they’ve actually taken on a lot more risk than they realize.
Nowadays, some of the best yields — on paper — are in the securitized marketplace. But those yields can be misleading. There’s no ready-made market for a lot of the trading going on. And because of ongoing government intervention in the form of mortgage assistance programs, it’s not really a free and fair market.
I stumbled onto mortgage real-estate investment trusts, or mREITs, from people walking into my office and telling me they want to put a third of their money in these vehicles because of the 12% to 14% yields. I have to stop them and ask if they have any idea what they’re getting themselves into. There has to be risk or it wouldn’t pay that much.
MREITs are REITs that consist of residential mortgages rather than commercial real estate. The trouble with mREITS is that nobody knows what they contain — they’re very opaque and hard to value. On top of that, we’re dealing with consumers on the individual residential level. There’s not much asset collateral like there is in the commercial real estate space. People might default, which makes the performance of these bonds much less predictable. I venture to guess that there are a great many people who are taking on a lot of risk without realizing it, all in an effort to solve the problem of generating enough income.
To combat this trend, advisers need to talk to clients about all forms of risk-interest rate risk, inflation risk, credit risk. Our willingness to tell our clients the cold, hard truth, no matter where it might lead, is our most valuable asset in this economy. If a client has searched for investments based on dividend yield, they likely came across investments like mREITs.
Though these vehicles might be appropriate for some investors, the average Joe doesn’t understand the amount of risk these investments carry. By being open, honest and forthright with clients about this, we can help them steer clear of mistakes that have the potential to do them harm.
Click here to read the entire article in the Wall Street Journal.
To learn more about Beatty, and his firm Egan, Berger & Weiner LLC, visit www.ebwllc.com.