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SJan 13, 2002

The Search for Safe Investment Income

Scott Burns
Seen any dividends lately? Collected any good interest payments?

Probably not.

As this is written, the 3-month Treasury is yielding a record low 1.66 percent. That's less than the trailing inflation rate, 1.90 percent. The average 3-month CD, according to Banxquote, yields even less, 1.48 percent.

Then the taxman will add insult to injury. Money market mutual funds are rapidly becoming sure ways to lost purchasing power--- with great safety.

Ironically, it may be worse when interest rates rise.

If that happens, the people fleeing equity funds for the safety of fixed income funds would get a double-whammy. Their new fixed income funds will decline in value as short-term rates rise.

So where do we put our money to get a reasonable income and some safety?

Here's a list of candidates:
  • iSavings Bonds. While the yield is now down to only 2.00 percent over the rate of inflation, that still promises to be over 4 percent, tax deferred. The only limitations: you can't buy more than $30,000 in a year and you need to hold for at least 5 years to avoid a penalty. For more information, check the Savings Bonds website.
  • Adjustable Rate Mortgage Funds. There are only 24 of these funds and some require large initial investments. They provide the benefit of a return that will adjust upward if short-term rates start to rise. While you could face small losses in net asset value if rates run up quickly, the value will catch up as the mortgages adjust upward. Asset Management Adjustable Rate Fund (ASARX) requires a $10,000 initial investment and had a trailing 12-month yield of 5.42 percent. Goldman Sachs Adjustable Rate Government Insured Fund (GSARX) requires a $50,000 initial investment and had a trailing 12-month yield of 5.68 percent.
  • Mortgage Funds. Mutual funds that invest in government insured mortgages might provide a good yield while protecting your principal. In early January the average 30-year mortgage yield, according to Bloomberg.com, was 6.72 percent, down only 3 basis points (3 one-hundredths of one percent) from the 6.75 percent of last January. During the same period, the federal funds rate fell from 5.75 percent to 1.75 percent. Message: The short end of the yield curve is more vulnerable than the long end. Vanguard GNMA (VFIIX) requires an initial investment of $3,000 and provided a yield of 6.32 percent in the last 12 months. In 1994, the worst year in fixed income history, the fund lost only 0.95 percent. SIT Government Securities Fund (SNGVX) requires an initial investment of $2,000 and provided a yield of 5.63 percent in the last 12 months. In 1994 the fund was among a handful of fixed income funds that didn't lose money.
  • Treasury Inflation Protected Funds. There are few of these. Only one has a long track record. TIPS are an indirect way of protecting yourself from rising interest rates because rates tend to rise with inflation and TIPS pay a fixed rate plus inflation. With 10-year TIPS now yielding about 3.5 percent plus inflation, the likely long-term return will be nearly 6 percent, less management costs. American Century Inflation Adjusted Treasury Fund (ACITX) has a minimum initial investment of $2,500 and provided a 12-month trailing yield of 5.35 percent. Inflation adjusted securities should be used in tax-deferred accounts.
  • Intermediate Term Municipal Bond Funds. Just as corporate bond yields haven't fallen as much as short term Treasury yields, all but very short term tax free bonds now yield almost as much as comparable term Treasuries. USAA Tax-Exempt Intermediate Bond Fund (USATX) has a minimum initial investment of $3,000 and provided a 12-month trailing yield of 5.17 percent. American Century Tax-Free Bond Fund (TWTIX) has a minimum initial investment of $5,000 and provided a 12-month trailing yield of 4.37 percent. If you are in the 28 percent tax bracket (or higher) these funds are likely to provide a long-term return similar to the after-tax return on Treasury Inflation Protected mutual funds.
If you're tempted to reach for more yield, remember the old Will Rogers line about the return of your money, not the return on your money.
Web Links to more information on investments mentioned in this column.
Investment Direct Source MoneyCentral
ISavings Bonds www.savingsbonds.com Na
Asset Management Adjustable Rate Fund www.shayassets.com Link
Goldman Sachs Adjustable Rate Government Insured Fund www.gs.com Link
Vanguard GNMA www.vanguard.com Link
SIT Government Securities Fund www.sitfunds.com Link
American Century Inflation Adjusted Treasury Fund www.americancentury.com Link
American Century Tax-Free Bond Fund www.americancentury.com Link
USAA Tax-Exempt Intermediate Bond Fund www.usaa.com Link
Source: MS MoneyCentral, U.S. Treasury

Filed Under: I Bonds & Tips, Income Investing