If the volatile financial markets make stuffing your mattress look like an attractive idea, fixed-income investments may help you sleep better at night.
"A fixed-income investment is a debt instrument with either a stated coupon value at maturity, or a fixed rate of return that will be paid for a fixed period of time," explains Richard W. Andersen, vice president of Kidder, Peabody & Company in Chicago.The primary attraction to these investments is security. Your principal investment is safe because it may be insured. For example, Certificates of Deposit (CDs) issued by banks or thrift institutions are insured by the Federal government. Others are considered safe because they are guaranteed by reputable institutions, such as with bonds backed by stable public corporations.
Most of these investments also offer easy access to your money. Although there is often a penalty for early withdrawals, some investments carry little or no penalty.
And, if the fixed rate of return is greater than current market rates, there is also the option of selling your instrument on the secondary market for an immediate profit. But if rates continue to rise, you could find yourself locked in with a low rate of return.
Here's a survey of some fixed-income investments:
***Money Market Funds. There are more than over 300 money market funds in the United States. They are not federally insured, but are considered safe because the funds are usually invested in short-term obligations of the U.S. government and large corporations.
"The beauty of a money market fund is its liquidity," said Andersen. "You have immediate access to your investment through a checking account or credit card, with no withdrawal fee or interest penalty."
Although other fixed instruments may lock in higher rates, a money market fund floats and is sensitive to interest rate changes.
***Certificates of Deposit. CDs, available at your local bank or savings association, offer a great degree of security because they are government insured. You know before you invest what your earnings will be and when you can collect.
Andersen warns that although CDs may be insured, one should still stay with quality banks. "The type of bank that needs a broker to sell its CD may not have the same quality certificate as another bank," said Andersen.
***Bonds. Bonds are promissory notes (usually worth at least $1,000 at maturity) issued by corporations and governments. However, all bonds do not necessarily reach maturity. Municipal and corporate bonds are often "callable" after a designated period of time. If market interest rates fall, chances are good that the issuer will redeem its debt obligations and replace them with new lower-yielding instruments.
The quality of the bond is determined by the creditworthiness of the issuer. Obviously, U.S. government securities are the benchmark of quality.
"A U.S. Treasury bond is my idea of quality," Andersen said. "They are highly liquid and easy to trade with a low commission."
All Treasury securities are backed by the "full faith and credit" of the U.S. government. They are exempt from state and local taxes and are available with various maturities. These obligations are issued for up to one year (called "bills"), two to 10 years ("notes"), or 10 through thirty years ("bonds"). Also, U.S. Treasuries are not "callable." They will always deliver on any guarantees promised.
If you decide to purchase a corporate bond, Andersen advises to "look for one with a recognizable name and that is traded on the New York Stock Exchange."
***Zero Coupon Bonds. Zeros technically pay no interest, but they promise to be worth a fixed amount at maturity and cost only a fraction of the bond's face value. However, the presumed interest (even though you don't actually collect it) is taxed every year. The zero's rate of growth is guaranteed, regardless of how close the bond is to maturity.
Zero coupon bonds have become popular in recent years as a means of saving for long-term expenses, such as a child's college tuition.
***High-Yield Corporate Bonds. Popularly known as "junk bonds," they are often used to finance corporate takeovers. These bonds have a higher yield, but they also carry a much greater risk.
"The overwhelming question with these bonds is, if there is a downturn in the economy, will the issuer be able to pay off the bond?" said Andersen. "Unless you have subsantial knowledge about a junk bond, the difference between a 12 percent bond and a quality 10 percent bond is not worth it. On a $20,000 investment, the difference is only $400."
The bottom line for investing in junk bonds is the same as every investment: How much are you willing to risk?
Reader questions will be answered and may appear in this column, when mailed to Gary S. Meyers at 20 West Hubbard St., Chicago, IL 60610.