Fixed income mutual funds are a convenient, low-cost way for clients to get access to a diversified portfolio of securities for a relatively small minimum investment. Better yet, investors have the option of choosing funds that are professionally managed by one or more experts.
But rising interest rates or a declining economy (or both) can cause a considerable amount of pain to bond fund investors, especially those who view their funds as a conservative source of income.
Here are some alternatives for those clients who are interested in seeking shelter before getting hit by any prospective storms:
1. Brokered CDs
Chances are your firm or custodian has millions of dollars of certificates of deposit in inventory at any given moment. Unlike most bond funds, these CDs offer government insurance of principal and interest, a stated maturity date and amount, and a predictable interest check until that maturity date.
Clients with CDs will always know where their money is invested, and, unlike bond funds, liquidations by other investors won’t affect the chances of clients holding the CDs until maturity getting their principal returned. Also, there are no return-reducing internal expenses applied to the CDs.
The yields on brokered CDs generally exceed the interest rates offered on Treasuries of comparable maturities, albeit with interest that, unlike Treasury interest income, is taxable at the state level.
In addition, investors with mid-six figures or more in investable assets can use CDs from several different institutions to receive government insurance coverage on all of their money, while keeping it in one brokerage account.
But clients new to brokered CDs should be aware that if they want or need the money invested in the CDs before the maturity date, the CDs will generally need to be sold at a price that may be more or less than the face value of the securities.
Even if clients hold the brokered CDs until maturity, until that date the valuations that show up on the account statements will reflect the estimated price if the CDs were to be sold at that time.
2. Bank or Credit Union CDs
If clients balk at the potential market risk of brokered CDs, they may be better off at a traditional bank or credit union, in a longer-term CD.
Most CDs issued directly by institutions impose an early withdrawal penalty of six or 12 months’ worth of interest, limiting the potential downside if clients need to cash out before they mature. This minimal penalty will be especially attractive if rates were to rise and higher-yielding CDs are available elsewhere.
Clients should ensure that their deposits don’t exceed the $250,000 federal insurance limit, especially if they are purchasing CDs in their investment account and on their own directly at the issuing institutions.
For more information on the insured permutations of ownership, they should check FDIC.gov for banks and NCUA.gov for credit unions.
3. Series I Savings Bonds
You might think of savings bonds as the dull pieces of paper you received from your grandmother for your first 20 birthdays. But clients looking for safe places for savings should get excited about several savings bond features.
Series I bonds are generally the most attractive version available today. The interest rate is tied to the Consumer Price Index and is reset every May 1 and Nov. 1. The most recent rate figure was a paltry 0.26 percent, but until May 1 of this year, the rate was 1.64 percent—better than what a seven-year Treasury note paid at the time.
Like Treasuries, savings bond interest is exempt from state income taxes. Better yet, clients can choose to pay taxes on the interest earned each year, or wait until the bonds mature or are redeemed to pay the taxes.
Technically, Series I savings bonds have a 30-year maturity. But after the bonds have been held for 12 months, there is only a penalty of three months’ worth of interest upon redemption. Once the bonds have been held for five years, they can be redeemed with no penalty.
A couple of cautionary considerations: Individuals can only purchase $10,000 in Series I bonds per person, per calendar year. However, up to $5,000 in additional face value can be bought with a federal income tax refund.
Savings bonds can’t be purchased in qualified accounts like IRAs. They have to be bought online at www.treasurydirect.gov (and the initial purchase process is a bit of a time-consuming hassle).
4. Stable Value Funds
Clients who still have at-work retirement plan accounts (like 401(k)s and 403(b)s) and are looking for a relatively conservative option should see if a stable value fund is on the roster of the plan’s investment choices.
Stable value funds are akin to fixed-rate annuities, except there is usually no surrender charge. The accounts generally offer a fixed rate of return for a certain period (say, one quarter or one year), that can be adjusted upward or downward for the period going forward.
The yields on stable value accounts can be attractive, usually similar to what is paid by an intermediate-term bond.
Clients can often pull money out of the stable value accounts at any time and be assured that they will receive their accumulated value with no concerns over market fluctuations—that is, if everything goes according to plan. The costs and composition of the underlying investment portfolio can be murky.
In times of severe financial crisis, this means that money invested in stable value accounts could be subject to some of the same risks facing bond funds, without the government-backed insurance and guarantees offered by CDs and savings bonds.
That said, stable value funds offer a unique investment proposition that you probably can’t duplicate. Therefore, if you encounter a client who still has money in a 401(k) or a 403(b), it may be a good idea to leave some money in the account to place in a stable value fund—just not too much.