What to Consider if You’re Inclined Toward Bonds

Interest rates are falling, you’ve got cash to invest and you’re wondering whether it’s time to lock in yields on longer-term investments.

You’re in good company: Practically every investment adviser in town is fielding questions from anxious clients on this subject. Tuesday, as Federal Reserve policy makers met, market interest rates slid further as traders bet that the Fed will soon push rates down another notch.

The yield on 30-year Treasury bonds, a benchmark for long-term interest rates, fell to 8.53% Tuesday from 8.62% last Friday. Tuesday’s yield was the lowest for the T-bond since July. As recently as mid-October, it was near 9%.

Rates are falling, of course, because of the expectation that the economy will continue to weaken, and with it the demand for money.

What to do? First and foremost, any truly objective investment adviser should tell you NOT simply to lunge for the highest yields you can find. Remember the junk bond debacle last winter? A lot of people chased those yields just a few months before the market collapsed. Many failed to understand that a bond investment has two sides: Interest and principal value. Both can change.

Instead of dumping tons of money into a single high-yielding investment, step back and map a strategy for yourself. The specifics will depend on your age, income needs and basic financial goals, but these guidelines should help any investor:

* Look at the yield versus the risk. You can nab 10% yields on international bond mutual funds, which buy bonds of foreign governments and foreign companies. Likewise, you can find various mortgage-backed securities--and mutual funds that invest in them--yielding up to about 9.5%.

Those are among brokers’ hottest products today. In both cases, a key sales pitch is that it’s easy to get your money out at any time, unlike locking dollars up in a bank CD. But you also have to be prepared to see the paper value of your principal shrink, if the markets move the wrong way and you stay put. For example, if the dollar rises against foreign currencies, international bonds will drop in value. And if market interest rates fool everybody and rise next year instead of fall, mortgage investments will drop in value.

Before you reach for those returns, ask yourself: Is the premium in those yields enough to compensate you for the risk to your nest egg? Many investors will say yes, but others may decide it isn’t worth the extra 1.5 percentage points when an ultra-safe one-year bank CD pays 8%. Don’t be talked into something you don’t understand.

* Be careful about “guarantees.” Another favorite broker sales pitch is that yields on government securities--Treasury securities or government-backed mortgages--are guaranteed by Uncle Sam. It’s true that the government guarantees that it will make its payments. Otherwise, says Jack Lemein, vice president at mutual fund firm Franklin Resources in San Mateo, Calif., the future will be “guns, butter and gold in the hills.”

But unless you’re buying an individual security, be aware that the interest you’re paid on a government-backed investment may fluctuate, depending on how the investment is packaged . A Treasury bond mutual fund, for example, will lower its payments to you over time if market interest rates fall and new, lower-yielding bonds are brought into the portfolio.

Always ask to see a history of an investment’s payments before you buy, to see what’s happened in periods of rising interest rates and falling interest rates. Don’t assume you’ll earn the same yield forever.

* Don’t try to predict interest rate trends. OK, rates seem to have every reason to drop from here, given the apparent recession. But might they just turn up by mid-1991, if the economy starts growing again? Who knows. And that’s the point: Don’t lock up your life savings in a 10-year Treasury note now at 8.4%, just because everybody says rates are going down, and money market funds pay just 7.5%. No one can say where rates will be in six months, let alone 10 years.

The better strategy is the simplest one--”laddering” your investments. Split your cash among a variety of maturities. For example, you might divide the money in equal portions among eight-year mortgage-backed bonds at 9%, three-year Treasury notes at 7.7%, a one-year CD at 8%, three-month Treasury bills at 7.3% and money market funds at 7.5%.

By laddering, says Frederick J. Ruopp, president of Los Angeles money manager Chelsea Management, you’ve covered yourself no matter what happens, because “you always have something rolling over.”

* Think about taxes. Tax-exempt municipal bonds issued by states, counties and cities are attracting deserved new attention, because federal income tax rates will rise next year. Muni bonds really are just about the last tax shelter left. And if you can invest exclusively in bonds of your home state, you generally get a double tax exemption--you don’t pay federal or state tax on the interest earned.

You can invest in California-only muni bond mutual funds now yielding 6.5% to 7%. If your combined federal and state tax bracket is 35%, a 6.5% muni yield is worth the same as a 10% taxable yield. That makes munis among the best deals around for yield-hungry investors.

What about credit risk? Certainly, if the California economy slides, more cities and counties could have trouble paying their bills. That’s why, for most investors, buying munis via a bond fund or other diversified package is a smarter step than buying individual bonds. Diversification lowers your risk dramatically.

Slamming Collins and Sizzler: Just how many people showed up for a steak or salad at Sizzler restaurants in October? Shearson Lehman analyst Caroline Levy in New York made negative comments about Sizzler on Tuesday, apparently telling clients that sales flattened.

Those comments helped send L.A.-based Sizzler’s stock plunging $2.125 to $10.625. Collins Foods, which owns 66% of Sizzler, lost $1.125 to $13.75. Collins also is L.A.-based.

Collins’ chief financial officer, Chris Thomas, says Levy “got it wrong.” He says Sizzler’s same-store sales were up in October versus a year ago. But he declined to say how much. Levy didn’t return phone calls.

What’s worrying investors is that the restaurant business is more competitive than ever, and price wars are breaking out everywhere. Nobody wants to be on board a chain that’s losing the battle for consumers--especially in a sliding economy.

Leslie Steppel, analyst at Prudential-Bache Securities in New York, believes that Sizzler’s same-store sales rose a respectable 4% in the quarter ended in October. Collins, which owns 209 Kentucky Fried Chicken restaurants, saw same-store sales rise 3%, Steppel estimates. Both chains are under pressure because of price wars, and Sizzler’s costs are up because of its new Buffet Court & Grill deli and appetizer bar, now being rolled out at the 650 Sizzler sites.

But Steppel still thinks that Sizzler’s concept is a winner in the long term. So does Collins. The parent said in September that it will sell its Kentucky Fried outlets to Pepsico Inc. and then turn around and buy the 34% of Sizzler stock that it doesn’t own.

That’s another reason why both stocks are likely to be very volatile until the deal is closed early in 1991: Investors still are trying to sort out the values in the complicated planned stock swaps involving Pepsico, Collins and Sizzler shares. There’s a good chance that more investors will decide to exit Collins and/or Sizzler soon rather than wait for a deal--which could mean bargain hunters will end up with Sizzler for a song later.

WHERE TO FIND GOOD YIELDS As market interest rates fall, more investors are considering buying longer-term instruments to lock-in high yields. Here are some investment ideas, the typical terms (maturities) and the current range of yields for each.

Yield or Investment Term range Intl. bond funds None 8.0%-10.0% Mortgage securities 3-10 yrs. 8.0%-9.5% Treasury bonds 30 yrs. 8.5% Treasury notes 10 yrs. 8.4% Bank CDs 1 yr. 7.5%-8.3% Treasury notes 3 yrs. 7.7% Money market funds None 7.0%-8.0% Treasury bills 3-6 mos. 7.3%-7.4% Tax-exempt bond funds None 6.5%-7.0%* Tax-exempt money funds None 4.5%-5.5%*

* real return would be higher, depending on your tax bracket

Source: Lipper Analytical Services; the IBC/Donoghue’s; Reuter