How to overcome the biggest risks in investing while earning a yield of 7% or more

Don't believe anyone who says there is no such thing as a safe investment. The truth is, all assets, from government bonds to housing to dividend-paying stocks, involve risk.

According to the Financial Industry Regulatory Authority (FINRA), the “safest” investments are short-term U.S. Treasuries. For example, if he lends the government $100, a year later he will get back $105.17. not bad.

However, there are some caveats.

1. Interest rates on short-term Treasuries fluctuate, and the Federal Reserve has said it will try to lower them later this year.
2. If a truly apocalyptic disaster occurs, you may find that the Federal Reserve won't pay your money back. In fact, you may find that money itself has no value.

The second point may sound silly, but I'm pushing the boundaries here and making the following point. Nothing in life is without risk. When investors talk about “risk-free returns” like in U.S. Treasuries, they assume that tomorrow will be the same as today. But maybe not.

Therefore, no matter where you put your money, you must accept that there is a possibility of loss.

Inflation risk is much more dangerous than people think (especially now)

What about cash, the ultimate safe investment? It's even more dangerous. Because of inflation, if you had $100 in cash saved five years ago, it would now be worth $78.80.

The reason is that the current 3.5% inflation rate makes money worth that much less than it did just a year ago, but of course inflation has made money worth less the year before that, and the year before that, and the time before that. Because they're devouring it…you get the idea.

In other words, Even cash is not safe.

I'm not writing this to worry you! Instead, think of it like this: You can control your wealth and turn it into more wealth. The key is hug It takes less risk and focuses a little more on the rewards investors get for taking it on.

For example, consider how someone who bought short-term U.S. Treasuries five years ago did so. iShares Short-Term Treasury Bond ETF (SHV) The orange color below would have compared to investors who bought SPDR S&P 500 ETF Trust (SPY)the benchmark S&P 500 index fund (purple).

That period included a pandemic, soaring inflation, and all sorts of other upheavals. Still, stocks crushed short-term government bonds. This shows that letting fear control too many investment decisions can be more harmful than we realize.

That may seem reasonable, but there are certainly ways to mitigate stock price volatility without sacrificing too much return. and Make sure your money is there when you need it.

This concern is probably most common among retail investors. And (of course!) Wall Street has the answer. It's a target date fund.

Here's how it works: Let's say you want your funds to be available in 20 years. So you buy a fund with a 20-year target date, put your money in it, stay invested, and ride the wave.

It's easier to demonstrate this through a real example, so let's put together a little scenario.

Let's say that in 2003, an investor wanted to retire in just over 20 years and bought a (then) newly launched product. Vanguard Targeted Retirement 2025 Fund (VTTVX).

Our investors are attracted to the set-it-and-forget nature of our funds. We're also attracted to VTTX because, over time, you'll reduce your exposure to stocks and move toward bonds for added safety and guaranteed retirement funding. Additionally, this fund is cheap, with fees only 0.08% of assets.

It is wonderful. Well, not so fast.

In the case of VTTVX (orange above), investors are now worth less than half of what they would have been if they had invested in the stock market. A $100,000 investment in VTTVX would yield approximately $261,200, while an S&P 500 index fund would yield approximately $613,100.

In other words, the fear cost them more than $350,000. This is equivalent to the price of a house or a Lamborghini.

Granted, SPY's drop was worse than VTTVX's, but this is an illusion. If we focus on stressful times like 2020, we can see that VTTVX's strategy didn't help much.

VTTVX still fell 20% during the crash, but this was better than the S&P 500's 30% decline. However, the index recovered quickly. As such, VTTVX holders were spared the pain of losing another 10% of their profits, but they also suffered the pain of a delayed recovery.

In fact, its recovery was not completely complete as VTTVX had underperformed since the coronavirus crash.

There is still one issue here: liquidity.

In 2023, VTTVX paid a 4% dividend, compared to the average S&P 500 stock's dividend of about 1.3%. That's why many investors point to targeted funds as a great income option. Sure, there's the idea of ​​sacrificing profits, but you get more cash flow in return.

Not exactly. At least, that's not the case when comparing VTTVX to closed-end funds (CEFs), an asset class in which all investors should seek long-term returns and high dividends.

Below you can see the total returns for VTTVX (purple at the bottom) and three CEFs focused on large-cap stocks. Adams Diversified Equity Fund (ADX),Orange, Central Securities Co., Ltd. (CET)blue, and General American Investors Company (GAM)displayed in green.

As you can see, all three are smashing their target date funds.

CET, in particular, has grown significantly thanks to the magic of compound interest stemming from the fact that it far outperformed its peers during the Great Recession. From the beginning of 2008 to the beginning of 2015, CET rose 53.3%, while ADX and GAM each gained about 35%.

And when you consider that these funds have paid an average of over 7% in dividends over this period, you can see why target funds don't make much sense. Cash flow is reduced and returns are reduced, but risk is not reduced much.

A final word: Targeted funds may seem attractive if you want to increase your retirement savings, but their low-risk approach also means they are likely to result in low returns, and of course no one I don't want it either.

Michael Foster is the Principal Research Analyst for: contrarian outlook. For even bigger income ideas, click here to check out our latest report.Undying Income: 5 Great Value Funds with Stable 10.9% Dividends.”

Disclosure: None