Watch out, seniors. The investment industry is about to smother you with love.
For a couple of reasons, seniors are a hot market for investment companies. They have big money after decades of saving for retirement, and they’re a huge demographic force. Statistics Canada has estimated that as much as one-quarter of the population will be 65 years of age or older in 20 years.
Investment firms have already started focusing on the senior market with products designed to produce investment income. These need particular scrutiny because they’re often designed to produce higher returns that people can get from guaranteed investment certificates and bonds. Higher returns equal higher risks. Never forget that.
Let’s look at some income products in this group and how appropriate they might be for your portfolio:
1. Diversified income funds
Available in both mutual fund and exchange-traded fund (ETF) formats, these funds mix bonds and dividend-paying common and preferred shares in a single package that pays monthly income. This is a super concept, in theory.
In practice, there are many good products to choose from and a few that are trying to tempt investors with mega-yields in the five per cent to 10 per cent range. What these funds are doing is paying investors each month with a mix of bond interest, dividends and a return of capital, which in much simplified terms means giving investors a little of their own money back. A return of capital isn’t necessarily a bad thing but, if it gets out of hand, it can erode the value of a fund over time.
2. Covered-call ETFs
These ETFs are hot sellers right now because they generate yields as high as 10 per cent to 15 per cent. They do this by holding a portfolio of stocks and then using call options, a kind of advanced financial instrument, to generate income from those stocks.
While people in the investment industry swear that covered-call writing is a sound and commonly used strategy, I’m uncomfortable with it in the ETF format because of those sky-high yields. I’m a big believer in the rule that when the yield on an investment climbs much above five per cent, the risk level grows steadily higher.
3. High-yield and emerging market bonds
These higher-risk bond categories are for younger investors. They offer higher yields than government bonds, but with significantly more risks. The trade-off just isn’t worth it for investors who must protect their capital.
Note: high-yield bonds are issued by financially weak companies, while emerging market bonds are issued by countries with developing economies.