Retirement Income Blog

Some foreign governments may offer a higher interest rate on their bonds than the US Government does. Additionally, some foreign corporations might offer a higher interest rate than the US companies. For retired investors, this could be an opportunity to diversify in an area that offers potentially higher returns, more stable returns and a hedge against the value of the US dollar–all goals for sound retirement investing.

Also, international bond funds can provide diversification and potentially higher returns. International bond funds invest primarily in bonds issued by foreign governments and corporations. There are different types of international bond funds—single country, single region, global (which includes US bonds), and foreign (no US bonds included).  There are also industry and sector funds—utilities, government, telecommunications, and so forth.

What are some other reasons to consider international bond investments?  Interest rates can move in different directions throughout other parts of the world. For instance, when US rates are low, rates in other stable countries may be higher. The same could happen to movements in the stock markets. Of course, the opposite could also come about. }

When you buy international bonds or bond fund shares you are opting for the potential of higher returns in exchange for accepting some additional risks. For example, foreign markets are often more volatile than the U.S. markets. These investments involve other special risks, including currency exchange, political and economic uncertainties as well. Professional managers can sometimes help to mitigate these risks by monitoring international market developments and by adopting strategies to hedge against currency exchange rates. However, the additional time involved in managing these risks will usually result in higher management fees. 

There are also international bond funds that invest in the area of emerging market bonds. Investing in emerging markets involves greater risk and potential reward than investing in more established markets. These markets tend to help when trade barriers are reduced (as is the case with NAFTA), or when privatization occurs in formerly communist or socialist countries. However, the risks associated with emerging markets include the risks relating to the relatively smaller size and lesser liquidity of these markets, high inflation rates, and also adverse political developments.

Investing a small percentage of your assets in international bond funds could potentially increase your income by giving you the opportunity to profit from growth in other economies. However, you should have a complete understanding of the associated risks of these investments.

The biggest risk (and potential reward) is the change in the currency rate relative to the US dollar.  For 2008, you would have been well off being in the US dollar as it did well realtive to other currencies.  But had you held Japanese Government Bonds, you could have gained 23%–just having your funds in a Japanese treasury bills as seen below (click on chart to see full view)

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Even with the bloom off the rose, investors still have interest in using real estate in IRAs.  The interest and use of real estate in IRAs peaked with prices.  Even as the real estate market cratered, real estate professionals with sagging commission income pushed IRA real estate (often mistyped or incorrectly searched as IRS real estate) on investors dissatisfied with stock market returns. But IRA real estate is a bad idea for IRA savings. Here are five reaons why real estate is a bad idea for tax sheltered retirement investing.

You lose the depreciation deduction.  One of the nice things about owning apartments or rental homes is that the cash flow is partially sheltered from income tax by the depreciation deduction.  Since an IRA does not pay current tax, IRA real estate loses the deduction.  Why would someone knowingly lose a tax deduction?  Because they are likely sold on the idea of real estate in IRAs by a zealous real estate sales person.  Or, they may only have liquidity in their IRA and no cash outside their IRA.  If you don’t have the cash outside the IRA, then pass on an IRA real estate purchase.

You lose financial leverage.  When you purchase real estate outside of an IRA, you can typically put 20% down and borrow the rest.  So when the property appreciates 20%, you have doubled your investment–a 100% return on your equity.  But an IRA real estate purchase cannot be done with any mortgages as IRAs cannot have debt.  So you must make the purchase for all cash.  Now, when the property appreciates 20%, you have a 20% return on your money, not 100%.  Therefore, you lose the leverage of “other people’s money” when you consummate an IRA real estate purchase.

You turn the best capital gains asset into ordinary income.  Because of the leverage explained above, you can have very large capital gains on real estate.  Not only do you lose the large capital gain potential because of losing leverage, you have turned  a capital gains taxed at reduced rates (15% to 25% on real estate), into ordinary income (rates as high as 35%). There is not such things as capital gains on IRA real estate because everything withdrawn from an IRA is taxed as ordinary income.

If the rental property in your IRA needs a new roof, you must use IRA funds to replace the roof.  You cannot use your own funds as then you as an individual are deemed to be in business with your IRA and this is a prohibited transaction which could cause your IRA to become taxable.  So you need to always have plenty of cash in your IRA for repairs, insurance payments and property taxes.  This means you need to keep funds liquid in 1a 3% money market and sacrifice the potentially higher returns of other investments. Need yet another reason?

Your IRA fees are likely free at your brokerage firm or bank.  To hold real estate in IRAs, you need a specialized IRA custodian willing to do this and the fees range from 40 to 150 basis points annually–i.e. hundreds of extra dollars in costs.

And just in case you still want IRA real estate, if you should make a bad deal, your loss will not deductible inside an IRA as it would be as a non-IRA transaction.  If you line up 10 people that tell you placing real estate in IRAs is a good deal, you will find 10 people that earn commission by selling real estate.  If you want real estate in your IRA, then buy shares of real estate investment trusts or other real estate securities.

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It’s a little crazy but investors with IRA savings want to know “what do I do now that my IRA account has dropped by 40%?” Would the best time to have asked that question have been before you invested the money?  To ask what to do now is like asking how to catch the train after it left the station.  So rather than succumb to the illogic of how to deal with a contingency when you had no contingency plan, let’s look at the rational way to handle your retirement savings from here on.

1. You can get all of your IRA savings out of the market and into a 2% money market fund.  This will insure that it takes a very long time to recover what you lost because at 2%, it takes 25 years to recover your loss.  Of course, the money market fund also insures that you won’t lose any more.  So you must ask yourself this question: does the market have a higher probability of going to zero or to 15,000?  Does Citicorp at $5 per share have a greater chance of going to zero or to $20?  If you think that there is a greater opportunity to the upside, then the money market alternative would be foolish.

2. You can sit tight and do nothing.  This means you have the same type of risk as when you started–the risk of loss or gain.  If you were willing to accept that risk before with your IRA savings, then why not now?  Additionally, consider that you have taken the risk and experienced the negative aspect of risk–don’t you need to stay in the market to experience the positive aspect of risk?

3. You can do something very irrational like invest all the money in gold because you heard some guy on CNBC says that gold is going to $2000 an ounce.  In other words, you lost money, are unhappy that you took so much risk and now want to take more risk with your retirement savings to gain it back.  Reminds me of the guy who lost everything in a card game and only had one asset left–his house.  In an effort to gain everything back he had lost, he wagered his house.  Does that seem like a crazy idea to you? If so, then you don’t try to gain your money back with an “all or nothing” bet.

4. What’s gone is gone.  You cannot think about “getting even.”  You have what you have and the best way to think of the right action is to ask yourself this, “I have $xxxx of retirement savings.  Based on what I know about myself and my emotional stability, my view of the future and my future needs, what is the best course of action NOW (with no reference to the past)?”

Hopefully, with these distinctions laid out here you can consider them calmly and the appropriate course of action will be obvious with your retirement savings.  And by the way–remember that your retirement savings are no different than the rest of your money (other than they grow tax deferred).  So if your non-IRA savings have been sitting in a money market during the market fall, look at everything you have and maybe you’re only down 10% overall and shouldn’t feel so bad.

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