What type of investment is right for you in 1996? Cameron Short takes a look at creating the best return on your investment dollars.
If you have traditionally kept money in short-term CDs, rolling your money year after year into another CD, you’ve found yourself reinvesting at lower and lower rates. If you have CDs coming due soon, you already know that your renewal rates could be as low as 2 to 3%. Plus, interest on CDs is taxable; your net return after taxes could be less than the rate of inflation.
However, before you renew your CDs, take a look at the alternative investments we’ve outlined. Keep in mind though, that CDs are federally insured, and offer a fixed rate of return. Both the principal and yield of investment securities (stock and mutual funds, in particular) will fluctuate with changes in market conditions.
Municipal Bond Mutual Funds
For investors with a time horizon of five years or more (including many investors who habitually roll over their one-or-two year CDs), mutual funds can be an attractive alternative. If you are a conservative investor, funds that invest in municipal bonds offer significant advantages, including professional management, diversification, monthly income and taxable-equivalent yields (net of sales charges) generally higher than CD returns. The minimum investment can be as low as $1,000. Some funds investing in the municipal bonds of specific states offer income exempt from federal, state and local income taxes.
Before you invest, be sure to request and carefully read the fund’s prospectus. It contains important information, including management fees and expenses.
Government Bond Mutual Fund
These funds, which invest in a diversified portfolio of government securities and are professionally managed for a maximum return, are a compelling alternative for yield-oriented investors. You should consider them long-term investments, however, and you must be willing to accept some fluctuation in investment value in return for an opportunity to get higher current returns.
Government funds offer monthly income that can be automatically reinvested if you like. The minimum investment can be as low as $1,000. Be sure to read the fund’s prospectus carefully before you invest.
Government securities include Treasury bills, notes, and bonds, all of which carry a high credit rating and a low degree of risk. Government securities are also available in other lesser known forms, including Ginnie Mae Securities and Zero Coupon Strips.
Ginnie Mae Securities
Also known as GNMA, the Government National Mortgage Association is a wholly owned corporation of the United States government. Each Ginnie Mae security represents a share in a pool of Federal Housing Administration (FHA) and Veterans Administration (VA) mortgages.
Ginnie Maes offer investors the highest yield of any security with a direct federal guarantee. Your regular monthly payment includes principal and interest, and will be the same amount unless a prepayment of principal is included. As with mortgage payments, the insert promotion will be higher in the beginning. You can purchase newly issued Ginnie Maes, whose principal has been paid down substantially, for as little as $5,000.
Zero Coupon Strips
Strips represent direct ownership in interest or principal payments on US Treasury notes or bonds. Like all zero coupon securities, Strips are purchased at a substantial discount to their maturity value, and, if held to maturity, lock in a fixed yield. Strips are intended for long-term, tax-deferred investing, and can be the perfect way for you to build wealth for the future. They mature four times a year (February, May, August, November), with maturities as long as 30 years, making it easy to target specific future need, such as your retirement or your child’s education.
Because accumulated unpaid interest on zero coupon treasuries is taxable, you should use Strips in an IRA or other tax-deferred accounts.
Fixed Rate Annuities
One of the few remaining tax-advantaged investments, an annuity, simply defined, is a contract between an investor and a life insurance company, guaranteed by the insurance company. You pay a premium, ordinarily a minimum of $5,000 and, in turn, the company pays interest on that premium for a specified period, known as the accumulation phase. Under current law, interest compounds tax deferred–it won’t be taxed until you take it out. IRS tax penalties may apply prior to age 59 and a half.
Many high quality stocks pay dividends that are at or near current CD rates. And while the value of a CD held to maturity never rises above your original investment, stocks have the potential to rise in value. You should be aware, however, that shares of stock, when sold, may be worth less than your original investment. In addition, the dividends on many high-quality stocks have risen consistently over the decades.
An alternative investment to your CD could offer you both the low level of risk and the higher returns you’re seeking. By adopting an alternative now, you can make 1996 the year to raise your returns.s
Cameron Short is the vice president of Gruntal & Company of Pittsburgh, Pennsylvania and may be contacted at 412-456-2100 for more information.