Take a Cue From the Pros and Play It Safe
A penny saved isn’t earning much these days. Banks and money funds are paying less than 7% on deposits where a year ago they were paying close to 8%. Treasury bills were paying 7.5% a year ago; now they are yielding 6.2%--which is no yield at all, considering that inflation last year was 6.1%.
And if all indications are correct, rates are going lower, toward 5%.
Small savers are in a quandary. Many people, especially retirees, plan household budgets around a certain level of interest income. They’re wondering now whether low rates are only temporary or should they trim their budgets. Or is it possible to seek a higher rate with safety?
The quick answers are, low rates will be around for a while but, yes, it is possible to get a higher rate by investing for a longer term--a three-year certificate of deposit, a five-year Treasury bond--but emphasize safety. In the 1980s, when interest rates declined, savers switched to junk bond money funds and other high-interest investments.
That’s not advisable today, when things are so tight that professional investors are keeping their heads down. Money funds have cut back severely their holdings of Jumbo CDs of banks--those over the $100,000 federal insurance limit. Instead, the money funds have more than trebled their holdings of T-bills and other Treasury securities. In commercial paper, the corporate IOUs that constitute half of all their investments, the money funds are now restricting themselves to only the highest-rated. That may sacrifice half a percentage point of yield but it increases safety, explains Neal Litvack, a vice president with Fidelity Investments.
If the pros are sacrificing yield for safety, take a cue.
But don’t panic. The important point is not that risk be avoided but that risk be understood. One irony of these times is that savers are shunning banks--where deposits are insured--to flock to money funds, which are not insured.
The fact is, if you have less than $100,000 on deposit in a federally insured bank, you can rest easy. Still, it wouldn’t hurt to check federal rules if you have more than $100,000 in multiple accounts at the same bank, advises Money magazine.
These are interesting times. We are living through a war and a recession and a restructuring of the banking industry. Almost two decades of inflationary assumptions are at an end, and the worry today is deflation--although what really comes next is hard to predict. But judgment is possible.
To begin with, banks are not broke but have plenty of money. The Federal Reserve, anxious to prevent bank failures, has eased up on reserve requirements, putting extra funds at the banks’ disposal. But the banks are not making more loans, explains Charles Clough, chief investment strategist of Merrill Lynch & Co. Instead, they’re investing the extra funds in Treasury securities--both because demand for loans is poor in the recession and because the banks are frightened, and thus shoring up their balance sheets.
That can be hard on small companies, which depend for financing on the $2-trillion supply of bank loans, much more than big business, which qualifies to borrow in the $550-billion commercial paper market.
But fears of widespread bank collapse are overblown. There are 12,399 banks in this country, and 200 may fail this year--fewer than 2%. There will be mergers and buyouts, but the industry that will emerge in the future will not be a few giant banks but thousands of banks--much as today. “It will be like the supermarket industry, where local companies are the standouts,” says Michael Morrow, a partner in Sheshunoff & Co., a bank consulting firm.
Meanwhile, present trends spell good news for borrowers. Banks and money funds buying up Treasury securities make it likely that long-term interest rates will soon come down--from over 8% to 7% or so--for five- and 10-year Treasury bonds.
Homeowners with variable-rate mortgages will get a break, and a lower cost of capital could spur a new business investment cycle, says Merrill Lynch’s Clough.
But for savers, a five-year bond would be preferable to the 10-year, because the long-term outlook for inflation is problematical.
Because of the war, the federal budget deficit is now conceded to be over $300 billion and headed toward $400 billion. The Bush Administration is determined not to levy a tax surcharge to pay for the war, so there will be a lot of Treasury borrowing, a lot of bond issues.
How will the government pay back that borrowing? Traditionally, say financial experts, the government pays off with depreciated currency--meaning inflation reduces the purchasing power of the bondholders’ principal. That’s why some smart people on Wall Street--Leon Cooperman of Goldman Sachs, Michael Price of Mutual Shares--predict rising inflation rates in the mid-’90s.
If that is true, stocks or stock mutual funds are the investment of choice on the theory that corporations can raise prices and keep earnings ahead of inflation.
The best advice on that one, however, is watchful waiting. If in 1993 or so you see long-term rates rising, that will be the market’s signal that higher inflation is coming. Meanwhile, if 1991 is hard to predict, who knows about the mid-’90s?
May you live in interesting times, of course, is an old Chinese curse.
