Investing with little market risk

By Bob Moeller, CFP,
WEAC's Member Benefits Manager

May 2001

Financial Planning Seminars
Achieving Financial Independence

I’ve received a few inquiries about how to invest wisely without market risk. Some people just received their quarterly variable TSA statements!

Also many people are concerned about generating income for use in retirement. A look at fixed investments may be in order for some of your funds, so I surveyed the market.

The goal is to get a fixed guaranteed rate of return with no stock market risk. This article is just to tell you what to expect, and does not mean I am recommending any of the possibilities. Data is as of April 23, 2001. Interest rates can change rapidly.

• Pay off high interest loans. If the interest you can earn is lower than the interest you are paying, paying off a loan is an investment. Tax deductibility has no role in your decision.
  
• Bank CDs. The key here is to shop hard and nationally. Decide how long you want to invest. Call a few local financial institutions. Call the NEA bank at 1-800-345-0397. Look at a current Money Magazine or similar national publication in the library and see what rates are being offered. Use the Internet if you wish. Pick the highest rate so long as it is insured and you are investing less than $100,000. Today, if you look hard, you can still find rates over 5¼% for one-year CDs. Don’t hesitate to ask your local institution if it will match a rate you found.
  
• Treasury paper. T bills, notes, and bonds are distinguished by their length of term. They range from one day to 30 years. Any interest received is exempt from Wisconsin state income taxes. Unfortunately, they don’t have a very good payout today given the fact that Mr. Greenspan has been seriously lowering interest rates. Going rates today are one year - 4.0%; five year - 4.9%; 10 year - 5.4%; and 20 year - 5.9%.
  
• EE bonds and I bonds. EE bonds are paying too low to deserve serious consideration, but I (inflation) bonds may be attractive. You get a fixed rate for up to 30 years (3.4% as of April 18, but may go down on May 1), plus the inflation rate. They provide good inflation protection, and in today’s market a good return of about 6.5%. (Again, rates will change May 1.) They are available at most local financial institutions. There are no taxes on accumulated interest until withdraw it. If registered in a parent’s name, they can be withdrawn for children’s college costs and no taxes are paid at all on the interest earned. Not a bad deal.
• Corporate Bonds. The bonds of major companies are rated AAA, AA, A, BBB, etc. If you’re concerned about safety, stick to A or better. The terms can vary from one year up to 30 years or more. Interest is paid each six months, fully taxable. If interest rates go up, the market value of your bond goes down, but if you hold to maturity, you get full face value (usually $1,000). Going rates today on typical issues are about 6% to 6.5% for shorter terms (less than 10 years) and about 7 to 7.5% for longer terms (10 to 30 years). Most members who want to get involved in corporate bonds should do it through a low-cost mutual fund such as the Vanguard family. Then your return will be a little lower due to mutual fund fees.
  
• Single premium annuities. With these annuities, you put your money in after taxes, earn an interest rate, with no taxes until the money is withdrawn. There is a 10% tax penalty if withdrawn before you are 59½. A lot of bad products are being sold by life insurance companies. Still, the concept – if done right – might be attractive to some people.
  

Here’s a fair deal as offered by Fidelity Mutual Funds: No sales charge; if you buy a five-year deal, you earn 5.5% APY for the five years; at the end of five years, you can renew, transfer to another annuity, or withdraw without tax penalty if you’re 59½; there are no taxes until funds are withdrawn. Fidelity’s fixed 10-year deal is 6%.

Be careful with these products! Frequently, insurance companies will advertise “teaser” rates for the first year or two, then guarantee a much lower rate for later years while at the same time charging you a huge withdrawal penalty if you take out the money. My advice? Make sure you really want this type of investment and then call Fidelity at 800-544-2442. Make sure you understand the charges, how long the rate is good, withdrawal costs, etc. You can then compare deals with others.

• Preferred stock. A cross between a bond and common stock, the typical preferred stock must be current on its dividends before any common dividends can be paid. If not, dividends accumulate and are owed to you. However, the preferred has only limited protective qualities in case of bankruptcy of the company. While a careful investor can earn a good annual rate here, (a rated preferred stock will pay about 7½% now), the typical member would be better off in a mutual fund specializing in this type of investment. You do have some market price risk here. If you are willing to take BBB rated stock (this is still considered investment grade), you can earn in the 8½% to 9% area with some real estate investment trust preferreds. Be careful, usually “preferreds” have a call date after which the company can call them in and pay you back the call price (usually $25, $50 or $100).
  
• Common stock. Currently, the two types of common stock most noted for dividend income would be utility stock or real estate investment trusts. A diligent investor could build a portfolio averaging 7%-plus with hopes for future growth, but there is risk. Again, an income-based mutual fund might be preferable. Those specializing in real estate investment trusts are numerous. The possible rate of return on directly selected REIT common stock is about 7% to 8%.
  

The point is that you can build an income stream through many kinds of investments, but you will not likely see huge rates of return on really safe investments. On the other hand, your risk of loss is much less, and in some investments there is no risk. Over the long haul, you are still wise to keep a good portion of your investments in solid, no load, equity mutual funds, either as a direct investment or as part of your tax sheltered annuity.

All things considered, the WEA Trust TSA fixed guaranteed rate of 7½% is a very good deal for 2001.

Posted May 2001