Is my 6% income strategy too risky?July 23, 2012: 6:30 AM ET
I recently put all of my retirement funds into TCW Emerging Markets Income fund (TGEIX). It is a Morningstar-rated, five-star fund with a yield around 6%. This allows my $2 million nest egg to generate enough income live comfortably without reducing my principal. The fund owns over 100 different bonds from several countries, so I feel there is some diversification built in. Am I making a mistake putting all my eggs in one basket? ― Michael K.
Unfortunately there's no free lunch, warns Paul Cochran, president of Providence Advisors Group in Knoxville, Tenn. The fund's relatively high interest rate in the current low-rate environment indicates that you're probably taking on more risk than you realize.
Don't let the five-star rating convince you that the fund isn't risky, says Cochran. TGEIX holds debt from emerging markets such as Venezuela and the Philippines, so it faces risks associated with politics — always a concern when investing in emerging markets — and credit quality (many of the fund's bonds are rated BB). If countries default on their obligations, TGEIX could fall sharply, as in 2008 when it shed 12.6% of its value.
While a $2 million nest egg is substantial, says Cochran, he also notes that size is relative. "It's a huge number, but it's a number that must be talked about in the context of one's lifestyle," he says. If you rely on every penny of income generated by this investment, a slight drop in value — or even an uptick in interest rates — could make it harder to meet your monthly expenses.
Meanwhile, Cochran also says the investment must match your tolerance for risk. "Some people are more comfortable losing money than others," he says. Instead of piling all your eggs into this one basket, Cochran recommends building a diversified portfolio that includes a variety of bond types. Depending on your risk tolerance , you may want to consider holding a ladder of high-quality individual bonds, an annuity, and traditional fixed-income holdings such as an investment-grade bond fund alongside this emerging market fund. "Diversification is diversification, regardless of the size of the investment," he says.
— Marc Mewshaw
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