Q: I was referred to a company that states that its corporate bonds have a yield of 9%. They claim that returns are “safe”. How is this possible?
A: It is impossible to be safe and realistic. Your suspicions are well founded. Still, it’s common to see “investments” that promise much higher returns than investments from real “safe” instruments (think bank CDs or US Treasuries). Promises of higher than these mediocre safe returns probably come with hidden risks (such as fraud), if not worse.
It was just over a year ago that we were informed that a 1-year bank CD would return no more than 2%, while crypto-based “stablecoins” are paying 9%+ returns. was. The literature (and some of the investors I spoke with) advocating these “high-yield, safe” investments seemed confident. The reasons for these returns being expected and “safe” were well explained. Needless to say, these “investments” are now worth very little just a few months later.
You should always try to understand the risks underlying returns that exceed those guaranteed by the US government (it is safe to compare using the 1-year bank CD interest rate). These risks are always there. always, always, always!
In many cases, you run the risk of not even getting back all of your original investment. Alternatively, the promised/expected interest return will be significantly less than advertised. Alternatively, the return on investment will take much longer than originally advertised.
Also understand that the promised safe return may not be “realistic”. For example, at the time of this writing, a 1-2 year bank CD would give him an interest rate of 3-4%. But after inflation (and taxes) the ‘real’ returns are pretty negative. Conversely, a broad stock market investment has no promise, but a reasonable expectation of a return on the investment that exceeds taxes and inflation (i.e., a positive “real” return) over a longer period of time. .
We also need to understand the time value of money in understanding returns. An annuity salesperson is piling up illiquid products that promise (and usually pay) a 4-5% return for him at twice her initial investment. But first, the insurance company will hold your money for 10 years, after which it will limit both the interest principal and the amount you can withdraw. The “real” return on such an investment can also easily be negative.
And don’t forget that if you fund an annuity company for 10 years without giving back and then receive a 5% return twice, it will take at least 20 years to recoup your original investment. Considering the value of the dollar back in his first 20 years, you’re under the water.
The cliché “There is no free lunch” applies strongly to the investment world. You were right to be skeptical about the proposals you received.