Interest Have It Record
Lows: How Can You Generate Interest Income?
Savers seeking to earn interest on their savings face a
terrible environment when looking at their alternatives. For those looking at CDs the conditions are
dismal. As can be seen form the graph one year CD rates
are near zero.
What are the
alternatives for a saver looking to earn more on their investments?
The good news is that
there are far more alternatives than existed a few years ago. The growth of
exchange traded funds in addition to some very low cost mutual funds mean that
savers find low cost investment alternatives with full transparency…you know
exactly what you own.
Don’t Forget the
Taxes ! Interest income is taxed as ordinary
income so it is important to manage your holdings to maximize not just the
interest you earn but also the income you keep after taxes. This requires one or both of the following:
Using equivalent instruments to those listed below that invest in tax free municipal bonds.
Placing bond holdings
in tax deferred accounts such as IRAs and 401ks where interest income is
tax deferred. Many 401ks don’t list the investment alternatives described in their materials
. However, you can often invest in
them by making use of a “brokerage
window” option which allows you to
invest in any of these alternatives. The
option is seldom publicized but easy to
establish.
A bit more
risk….higher return
Unlike CDs none of these investments are as safe as CDs. For
2 reasons:
Credit risk…unlike CDs these investments do not guarantee
full return of principal…the issuers of the bonds could go bankrupt. But with
the investment alternatives used here highly diversified holding 100s of
individual bonds so that risk is minimal.
Interest Rate Risk:
Bond investments of this type do fluctuate in principal value as market
interest rates change…..but this is simply a market price reflection of the economic
consequences of your investments. CD investments have similar risk it just
exists in the opportunity costs. In the case of thse instruments the price will
fluctuate with market interest
rates. If interest rates fall the
principal increases in value reflecting the fact that you have locked in a CD
interest rate above those in the current market, if market rates go up the
price of the investment goes down reflecting the higher interest rate
alternatives currently available….
But if one looks at this more carefully this is no different
economically to CDs. If you invest in a
2 year CD and lock in that rate and rates rise you have an opportunity loss
compared to buying a 3 month cd and renewing it every 3 months as rates rise.
The only difference is that in the case of the CD the consequences of changes
in interest rates are in an opportunity
loss (locking in below new market rates)
or windfall gain (locking in rates above new market rates).
So What Are the Alternatives?
The alternatives described above have three things in
common: they have truth in labeling and are always fully invested in a specific
segment of the market and they have fess lower than virtually all alternatives,
often below .20% so the impact of fees on your interest income is minimal.
While each investor should pick the mix of instruments. Here
is a list of those that make up the holdings in our client portfolios. They are
differentiated by maturity and credit risk
Short Term Bonds:
Since these bond instruments invest in maturities from one to three years, the
fluctuations in principal are limited:
Here are the alternatives in ascending levels of risk (and
return) all own a large portfolio of bonds thus diversifying the portfolios.
Short Term Bond Index
ETFs: These invest in both government and corporate bonds. Current yield .60%
Short Term Investment
Grade Corporate Bond ETFs: These invest
in bonds of the most credit worthy corporations. Current Yield: 1.6%
Short Term High Yield
Bond ETFs: These funds invest in
“junk “bonds those corporations deemed less creditworthy. The large number of bonds of numerous
corporations reduces some of the credit risk of any individual corporation. As
indicated in the title the higher credit risk means higher yield currently 5.92%
Intermediate Term
Bonds: Since these bond instruments invest in maturities from three to five
years, the fluctuations in principal are limited but higher than short term
bonds, they also carry a higher interest rate:
Here are the alternatives in ascending levels of risk (and
return) all own a large portfolio of bonds thus diversifying the portfolios.
Intermediate Term
Bond Index Funds: Since these funds
are composed of intermediate term 3-5 year bonds they carry more fluctuations
in price as they lock in rates for a longer period. Current
Yield 1.78%
GNMA mutual funds:
These funds invest in GNMA securities which carry the full faith and credit of
the US government, the same credit risk as Treasury Bonds. But they carry a
higher yield currently 2.5%
Intermediate Term Investment
Grade Corporate Bond ETFs: These invest
in bonds of the most credit worthy corporations. Current Yield: 2.88%
Intermediate Term
High Yield Bond ETFs: These funds
invest in “junk “bonds those corporations deemed less creditworthy. The large number of bonds of numerous
corporations reduces some of the credit risk of any individual corporation. As
indicated in the title the higher credit risk means higher yield currently
How to Implement an
Investment Strategy with These Instruments:
Do it on your own: research the various alternatives in each
category and construct a portfolio that matches your risk tolerances purchases
the investments through a discount broker.
Get some help.
Through our advisory services we work with clients in 3 ways:
A Model Portfolio you
implement on Your Own: We give you
an exact portfolio for you to implement through purchases executed on your own
for a one time consulting fee.
Initial
Implementation of Your Portfolio: You
engage us as your investment advisor for 3 months at a pro-rated annual fee+ a
consulting fee after that you manage the portfolio on your own
Ongoing management of
the Portfolio: We completely manage the portfolio for you for an annual
asset management fee + the initial consulting fee.
Feel free to contact me for a free initial consultation or an
opportunity to attend a presentation on this subject.
