As capital markets have risen and fallen in value like the tides rushing in and out in the Bay of Fundy, global investor expectations have grown increasingly resigned to more short-term volatility.

The US Federal Reserve last week lowered interest rates again by 75 basis points (A basis point is one-100th of one percent 1/100) to stimulate the economy and increase money supply available for financing.

Local financial institutions here promptly followed the yield curve downward by dropping both deposit and mortgage rates (on adjustable rate mortgages) 50 basis points, the second such adjustment over the last couple of months. As we watch this turbulence, most of us, I think, are now remembering more than we would like to admit that this is looking remarkable like the Bear Market of 2000-2002.

This view is, of course, a matter of perspective depending upon the directional change in your own economic circumstances

1 You are very happy if you own your own home with a big mortgage, since now, the interest due per month is lower leaving more free dollars to pay down on that massive principal debt, or as one fellow put it, the millstone around your neck.

2 You are about to become further challenged if you are retired, living on a fixed income, mostly derived from savings. Your interest income will be lower as the inflation rate in Bermuda, particularly on everyday necessities continues to ramp upwards. Yes, I know it seems like you just recovered from the last bout of low interest rates.

3 You are about to put off your grand effusive retirement, opting for a more minimal simple celebration because the interest rate on your proposed annuity payout is ludicrously less than inflation. Deferring your pension's annuity distribution in a low interest rate market is not necessarily a bad decision, if other options are available. Space does not permit full discourse on this one. Look for another article just on annuity choices.

4 Your investment account is swooning, more or considerably less, depending upon how it is managed and the risk tolerance allocations chosen.

The old adage that stocks beat bonds, and bonds beat cash may not hold true in times of market volatility. It often does not in many other situations because so much of any investment decision is dependent upon you, your family, your financial circumstances, your goals, your (almost) guaranteed employment surety, your culture, and your physical health.

In periods of market uncertainty, this adage becomes like a game of rock, paper, scissors where cash beats both stocks and bonds in the short run.

"One percent on my savings account is simply unacceptable, stated one individual, in 2003. I refuse to accept it and I will find a higher rate somehow somewhere." Everyone is now on a mission to find some savings/investment above the interest rate that they can obtain on their savings, if only to keep up with inflation.

Be careful of what you look for. Is there such a thing as a guaranteed high rate of return? Sometimes, it seems from the wording that it is. Hah, we should all be so lucky; we could ignore the stock markets and live in clover, or at least at the beach. Therefore, dear readers, a few basics are in order here, along with understanding that there can be severe traps waiting for you in this quest.

What is risk-free? Simply, all investments are measured against a very important benchmark, the risk-free rate of return. Thus, it follows that anything above the risk free rate has additional risk attached to it. The US two-year Treasury bond is currently paying a risk-free interest rate of just two percent.

Wickipedia defines risk free as an asset that has a certain future return. Treasuries (especially T-bills) are considered to be risk-free because they are backed by the US government. Notice even here, they do not say guaranteed.

The risk-free interest rate is the interest rate that it is assumed can be obtained by investing in financial instruments with no default risk. However, the financial instrument can carry other types of risk, eg market risk (the risk of changes in market interest rates), liquidity risk (the risk of being unable to sell the instrument for cash at short notice without significant costs) etc.

Risk-free and risk premium are not the same! Because the risk-free return is typically the lowest return offered in the marketplace because it is considered the safest, investment managers, financial institutions, capital markets and the like, will offer a return above risk free in order to generate investment activity, purchases and sales. There is nothing wrong with this; if you, as an investor, are willing to take on that extra risk - the risk of loss - you must be compensated handsomely for it.

"Internet Banks offer seven percent." "Five year investment will yield eight percent, lock-up required." We have all seen the signs, read the Internet bouncy ads, and heard about these investments from friends. Awfully, tempting. But step back a bit!

The Risk Premium is the amount that is paid above the risk-free rate. Remember this equation - the higher the percentage rate above two percent, the greater the risk inherent in the investment. And herein lies the crux of the matter. Logically, if risk-free is two percent, and the investments above are offering four times as much, you need to know how.

Consider this. An eight percent in this market is incredibly aggressive. Yet, investors increasing state that they do not like risk, are afraid of losing money, and so on. If that is your feeling, then you must practice due diligence and ask for every bit of information on this high interest bearing investment. Ask how this return is being generated? Is it a leveraged investment in disguise? What is the financial strength of this organisation, can you be made whole if it defaults? Is it partly an equity parcel? Is it exposed to the sub-prime market? What is it, you absolutely need to know. Never take an investment on faith.

An old story about emerging market speculative offerings where Argentinian government bonds come to mind.

In 1999, their government issued millions of these bonds, paying 13 percent interest. Investors all over the world bought them. Three years later, the economy ran into severe trouble, and the Argentinian government reneged on their gigantic IOU. They defaulted on principal payments. Instead, every investor received a letter stating that they would buy back the bonds, alright, but not a 100 percent on the dollar, but at 30 cents on the dollar - take it or leave it.

If you had invested 10,000, you would receive 3,000 back. Some return! 13 percent interest rate, but a 70 percent principal loss. I had a client who owned both Brazilian and Argentinian bonds. He was upset about his loss, but when I suggested that he sell the Brazilian bonds at par (and receive all his principal back because we had heard that Brazil was in trouble too), he refused. "It pays a great interest rate, and I am keeping it."

With that I gave up. Sometimes, not only do we never learn from our past mistakes, we repeat them again and again. Do not let that be you.

Martha Harris Myron is a Senior Wealth Manager at Argus Financial Ltd., specialising in comprehensive financial solutions and investment advisory services for individual private clients and their families, business owners, endowments and trusts. Direct line: 294 5709 Confidential email can be directed to mmyron@argusfinancial.bm

The article expresses the opinion of the author alone. Under no circumstances is the content of this article to be taken as specific individual investment advice, nor as a recommendation to buy/sell any investment product. The Editor of the Royal Gazette has final right of approval over headlines, content, and length/brevity of article.