Posted on: Sunday, December 21, 2003
Investment income this year paltry at best
By John Waggoner
USA Today
If you're looking for income as Christmas draws near, you'd swear that the Grinch is your banker this year. Your check from your savings won't go far at the mall: Like a Grinch heart, it's two sizes too small.
But don't skip the ribbons! The wrapping! The presents! You can still find investments to make your New Year more pleasant.
Actually, many income-bearing investments don't have returns the size of a Grinch heart. They're smaller. Consider this: The average money market mutual fund yields just 0.53 percent, says iMoneyNet, which tracks the funds. The absolute Grinchiest fund, Ivy Money Market fund C, has a 0.01 percent yield. That's a penny for every $100. At that rate, you'd need to invest an awful lot of Who-cash to buy a can of Who-hash.
Other savings rates are better, but not much. The average one-year bank CD will pay you 1.7 percent, says Bankrate.com. That's slightly less than inflation, which rose 1.8 percent over the past 12 months.
To get more income, you'll either have to commit your money for a longer period or take more risk. For example, if you invest in an average five-year CD, you'll boost your yield to 3.6 percent.
The drawback: You're locking in a 3.6 percent rate for five years. If interest rates rise, as they probably will, your 3.6 percent will look pretty paltry. You can increase your income and take advantage of rising rates by creating a CD ladder — that is, buying CDs of different maturities. If you bought a six-month, one-year, two-year and five-year CD at the current average rates, you'd have an overall yield of 2.2 percent. If rates rise 1 percentage point in a year, you could reinvest your six-month and one-year CD rates at those higher rates. After a year, your CD ladder would yield 2.7 percent.
Those are average yields. You can boost your returns further by hunting for top-yielding CDs.
If you're willing to take more risk, you could invest in bonds. A bond is a long-term IOU issued by the U.S. government, a corporation, a state or a municipal entity, such as a town, toll road or airport. It pays regular interest until it matures, at which point you get your money back.
Most people invest in bonds through mutual funds. Bond funds have two drawbacks, however. First, they all charge fees to manage the fund, which reduces your yield. Bond yields are close to the same level as when "The Cat in the Hat" was published in 1957. So make sure you buy a fund with rock-bottom expenses — preferably less than 0.75 percent a year. Two low-cost funds with top returns the past 10 years are the Fremont Bond, (800) 548-4539, currently yielding 3.28 percent; and the Vanguard Intermediate-Term Corporate Bond, (800) 662-7447, currently yielding 4.35 percent.
A municipal bond ladder could yield more after taxes than a CD ladder, and with relatively little extra risk — provided you don't sell your bonds until they mature. Muni bonds have lower yields than corporate or government bonds, but interest is free from federal income taxes. A sample muni ladder is in the chart.
Another good choice: Treasury Inflation-Indexed Securities, or TIPS for short. Like other bonds, TIPS pay a fixed interest rate. And like bank CDs, the government guarantees your investment. Unlike with CDs or other bonds, the Treasury will add to your principal according to the rise in the consumer price index, the government's key inflation measure.
Suppose you invest in a $1,000 TIPS that pays 2.5 percent interest. Inflation runs at 1 percent the first six months. The Treasury adjusts your principal upward by 1 percent, to $1,010, and the Treasury pays interest on $1,010 instead of $1,000. Over the years, that adds up.
TIPS have one tax drawback. You don't get the inflation adjustment to your principal until the bond matures. But you owe taxes on the adjustment every year. So they're best left in individual retirement accounts.
You can buy TIPS directly from the Treasury, through its TreasuryDirect program (www.treasurydirect.gov). You can also buy them through a broker.
What if you're just saving for next year's present for Cindy Lou Who? You'll have to search the neighborhood for a bank with a decent savings account yield.
But don't be surprised, when you open the door, if the Grinch isn't there, minding the store.
