CDs MATURING? TAKE ADVANTAGE OF THE OPPORTUNITY TO MAKE YOUR CASH WORK HARDER
By: Carol Richards
Carol Each individual investor has different investment objectives and different financial resources. Therefore, not all investments are right for everybody. However, the time is right to reevaluate the holdings in your investment portfolio and consider taking advantage of higher yields currently available for fixed income investments -- especially if you have certificates of deposit (CDs) maturing.
This conclusion is based on the following reading of recent economic trends:
Returns on bonds are likely to exceed those on cash and cash equivalents over roughly the next year.
Most of the rise in long- term interest rates is probably behind us.
The economic/inflation outlook suggests slow growth for 1995, as the Federal Reserve takes the necessary steps to keep inflation under control.
Investing in fixed-income securities involves a two-part strategy; tax-exempt and taxable.
Tax-exempt. The 10 - 17 17-year range continues to provide some of the best values, although a shortage of bonds continues in some states with high local taxes. You should act quickly when issues become available and you may also want to consider state-specific mutual funds and unit trusts.
Taxables. Consider this two- tiered approach to investing in this area:
Shorter-term. Treasuries, agencies, corporates maturing in 3-5 years, and CDs.*
Longer-term. Longer maturity Treasuries and agencies, preferred stock, longer-term corporate bonds, and, where appropriate, zero- coupon bonds.
What types of fixed-income investments are right for you? And what maturity structure is most likely to help you reach your long-term goals? The answer is as individual as you are. Your financial consultant can be one of the best sources for the information you need to help you make informed investment decisions. Here are some specific high-quality fixed-income investments you may wish to discuss with him or her.
Treasuries/Agencies. Consider Treasury notes as an intermediate alternative to cash. Also, since Treasuries are exempt from local taxes, some investors who are having difficulty finding high-quality municipal investments are turning to Treasuries. These securities often form the basis for retirement accounts. In addition, you may want to consider some of the many agency securities that are backed either directly or indirectly by the U.S. government.
Brokered CDs. If you'd like to hold CDs in your portfolio, some brokerage firms are offering higher CD rates than those available at local banks. Speak to your financial consultant before you roll over your next CD.
Zero-coupon bonds. Taxable zero-coupon bonds pay no current interest, but do create an annual tax liability. Consequently, they are particularly suited to retirement accounts where taxes can be deferred. In addition, tax- exempt zeros may provide a useful planning tool for taxable accounts.
"Laddering" your bond maturities is an effective way to build wealth and manage the cash flow of your portfolio. In a laddered portfolio, an investor simply buys bonds that mature sequentially over a specified period of time. There are a number of advantages to laddering. First, a laddered structure tends to reduce swings in yield on a fixed-income portfolio. The reason is simple. With a laddered structure, you will continually have bonds maturing. You can then reinvest the proceeds of your maturing bonds at prevailing interest rates - or at higher than current levels if interest rates increase or at lower than current levels if rates decline. Consequently, a laddered portfolio does a much better job of reducing overall fluctuation than putting all of your money in one bond or maturity range.
Second, a laddered structure tends to lower market risk. Market risk, as measured by a bond's volatility as interest rates change, increases less rapidly than the increase in maturity. (For example, a 10-year bond may be only 1 1/2 times as volatile as a five-year bond, not twice as volatile.) Consequently, a laddered portfolio with an average life of six years will usually have lower market volatility than a portfolio consisting of bonds that all mature in six years.
The maturity structure and initial cost of constructing a laddered portfolio of fixed- income investments will vary depending on your own individual needs. A good financial consultant can help you construct the kind of laddered portfolio that is most likely to help you meet your long-term investing goals, and can give you more information about each of the types of securities discussed above.
* Unlike alternative investments, CDs are insured by the Federal Deposit Insurance Corporation (FDIC) for $100,000 per depositor, per issuing institution and pay fixed rates and return.
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