Cutter Family Finances: The Danger of Risky Investments
By: Jeffrey Cutter, January 23, 2014
Often, folks will ask for my opinion on financial decisions that they have made. These people usually are looking for another opinion because in their "gut" they feel like something is not right with either the decision they have made or the information they have been given.
This brings me to a recent conversation I had on the telephone with a gentleman from Nantucket; let's call him Allan. Allan described himself as an extremely conservative investor with a focus on income to supplement his Social Security benefits. Allan has about a million bucks and while discussing his current portfolio, I asked him to walk me through his financial decision process when he decided to purchase bonds in a company called SolarCity.
Allan captured my attention with his answer. Allan told me that he received a telemarketing call one night from a representative from SolarCity, who offered to put solar panels on his house for "free." Allan said that the representative explained to him that if his electric bill was typically $150 or higher, SolarCity would install solar panels on his home at "no cost" to Allan. According to her, the new solar panels would cut his electric bill by roughly 65 percent. Of course, part of the savings would be remitted to the solar-panel company to pay for the "free" solar panels. Allan thought this was a good business model. So after some research, he decided to purchase some of SolarCity's bonds because they were paying a higher interest rate than the bonds in his current strategy.
Hmmm . . . As I tell my girls, nothing in life is truly "free." Time to investigate.
As it turns out, our friends at the Federal Reserve have made this business model possible. In fact, companies such as SolarCity have developed a new "system" for rolling out solar power. Get this . . . SolarCity will lease the equipment to its customers, who then make lease payments back to SolarCity using a portion of their electric bill savings. Brilliant, I say, and apparently perfectly legal.
Of course, the tax credits and other incentives go to the solar company as well, but the real meat of this program is in the lease.
So, SolarCity is not using its own cash to finance the purchase of the solar equipment that it is leasing to people like Allan. Instead, SolarCity is bundling up these leases and using them to secure bonds. The money it receives from issuing these bonds replenishes SolarCity's account so effectively, SolarCity is no longer financially reliant on those retail customers. And who would want to rely on retail customers who agree to lease solar panels for decades?
Think of all the things that could go wrong with a 20-year lease on solar panels. What if a roof needs maintenance, or a homeowner moves (at which point the homeowner must buy out the lease if the new owner doesn't agree to assume it), or if the homeowner's electrical use decreases while the lease payment remains the same?
These are just a few of the issues I thought of in only a few minutes of thinking about Allan's financial decision.
The only logical conclusion is that SolarCity, must be paying a lot in interest on such bonds, right?
These BBB+ rated bonds (two notches above the breakeven point for investment grade or junk bonds, which means there is a much higher default risk over A-rated corporate bonds) yield a whopping 4.8 percent!
Yep, you, too, can own bonds that are backed by 20-year residential solar panel leases and earn less than 5 percent on your money. There's only one person to thank for this and that's Ben Bernanke. With his foot firmly on the neck of investors as he holds interest rates to historical lows, people are desperate for any yield they can get, causing my new friend Allan to assume more risk than he otherwise would.
This means that companies like SolarCity can issue bonds at ridiculously low yields, given the nature of the investment, and investors will gladly buy them.
It also means that consumers are so desperate to save money—even $30 or $40 per month—that they'll agree to a 20-year lease on solar panels. Part of that desperation probably comes from the inability to earn anything at all on modest savings accounts, another gift from the Uncle Ben.
I told Allan what I will tell you, Cutter Family Finance readers. Don't fall for the promise of a mediocre yield in return for a very risky investment. You must have a sound financial decision making process, especially in financial times like these. And, don't ever believe someone when they tell you that you are getting something for nothing.
Needless to say, Allan is coming in to the office next week to review his financial decision-making process; probably a good idea.
Be vigilant and stay alert, because you deserve more.
* * *
Jeffrey Cutter, CPA, PFS is the managing partner from Cutter Financial Group, LLC (www.cutterfinancialgroup.com), which provides private wealth and investment management through low risk, low volatility successful financial solutions; securing peace of mind. He can be reached at firstname.lastname@example.org.
Investment advice is offered by Horter Investment Management, LLC, a Registered Investment Adviser. Insurance and annuity products are sold separately through Cutter Financial. Securities transactions for Horter Investment Management clients are placed through Pershing Advisor Solutions, Trust Company of America, Jefferson National Monument Advisor, Fidelity, Security Benefit Life and FC Stone. 1. http://tinyurl.com/nwvbep4