Savers Face Questions of Where, When as Interest Cut Looms

It’s decision time for savers: If interest rates will soon be coming down with the slowing economy, this may be the last shot to lock in decent yields.

Federal Reserve policymakers, meeting today, are likely to tell the nation that they’re prepared to cut short-term rates early next year to bolster the economy.

Yields on some investments, primarily longer-term Treasury bonds, have been falling for weeks, anticipating that the Fed would begin to unwind the interest-rate increases it put in effect from mid-1999 to May of this year.

Now, other yields also are beginning to slide as the market bets that the Fed will reduce its key short-term rate, now 6.5%, starting early in 2001.

For savers, “The best advice we can give now is to lock as soon as possible for as long as possible,” says Michael Larson at Bankrate.com, a rate-tracking Web site. “Certificate of deposit rates have peaked, are falling a bit and are likely to fall further. If you are looking at any kind of savings, the time to lock in a yield is now.”

Of course, there is no guarantee the Fed will cut rates--or that it will cut deeply. If the economy is stronger than expected in 2001, the Fed could begin raising rates again.

Most economists, however, believe rates have indeed peaked.

For investors and savers who want to lock in yields, there are many options, though all have trade-offs.

The first question to ask is whether you can afford to lock up your money. If you will need it soon, a short-term account may still make the most sense for you.

For those who do want to lock in yields, here are some ideas:

* Bank CDs are likely to be where many savers turn. Yields on the highest-yielding CDs range from 7% to 7.7%, depending on the institution, the deposit amount and the amount of time you lock up your money.

The average 1-year CD now yields 5.62%, according to IMoneyNet.com, which tracks yields. That’s well below the average money market fund yield of 6.01%. But if the Fed begins to cut rates, money fund yields could fall quickly: In late 1998, as the Fed reduced rates, money fund yields fell as low as 4.5%.

It pays to shop around for CDs. On the Web, you can try https://www.bankrate.com or https://imoneynet.com to find the top rates. As you shop, ask about early-withdrawal penalties. With a CD, you’ll typically pay an interest penalty if you withdraw your funds before the maturity date. The penalty varies based on the bank and the CD term, but it’s not uncommon to forgo one-quarter of your interest earnings if you withdraw early.

* Treasury bills, notes and bonds yield from 5.95% currently to 5.13%, depending on the maturity. Those yields have already dropped sharply in recent months, and in some cases are below average bank CD yields for the same term. The two-year T-note yields 5.32%. The average two-year bank CD yields about 5.6%.

But Treasury interest is exempt from state income tax, while CD interest is fully taxable. That can make a big difference depending on your state-tax bracket. (Treasury interest, like CD interest, is subject to federal income tax.)

* TIPS, or Treasury Inflation Protection Securities, offer a return that’s adjusted for inflation over time.

You invest a set amount and earn a relatively low current yield. However, the Treasury adjusts the principal value of your investment each quarter to reflect the rise in the consumer price index.

For someone who is worried about the effect of inflation on future buying power, TIPS can be a good deal, says William Scapell, fixed-income strategist at Merrill Lynch in New York. However, Merrill recommends them only for people who are investing within a tax-favored retirement account. Why? TIPS generate taxable income from profits that you don’t immediately realize. So to avoid a tax headache, it’s best to hold them in tax-sheltered accounts.

An alternative: I-Bonds, the Treasury’s inflation-adjusted Savings Bonds. For more information on I-Bonds, go to: https://www.publicdebt.treas.gov/sav/sbiinvst.htm.

* Individual corporate bonds yield more than Treasuries. But to buy an individual corporate issue, you will almost certainly need a broker’s help. The risk with any corporate issue is that the issuer could default in a bad economy.

* Municipal bonds offer yields that are exempt from federal and state income tax. “If you are in the 36% bracket or higher, municipals are almost a no-brainer” now, Scapell argues.

New five-year California state muni bonds recently yielded 4.2%. For high-bracket taxpayers, the taxable-equivalent yield--or the yield you’d have to earn on a taxable investment to take home the same amount after-tax as you earn on a 4.2% tax-free municipal--is in the 6.5% to 7.5% range.

* Those investing through 401(k) or 403(b) plans at work may want to consider guaranteed interest contracts, often called stable value funds. GICs are generally offered by insurance companies that promise to pay a set rate of interest for a specific period, such as a year. The average return on these funds has been about 6% in 2000.

The other usual income option for those investing through a 401(k) are bond mutual funds. These typically earn more generous returns than stable value funds. But bond funds don’t allow you to lock in a yield. However, the advantage of a bond fund, or an individual bond, is that it can rise in value as market interest rates fall.

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Hunting for Yields: A Sampling

Here’s a look at how yields on some popular savings vehicles and investments have changed since Nov. 1. Yields on Treasury securities have taken the biggest tumble, as investors have rushed to lock in returns. Yields listed here for bank accounts and money market funds are national averages. Higher yields are available if you shop around.

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Simple annual yield: Change in Security/account Nov. 1 Latest points Money market bank account 3.02% 3.06% +0.04 3-month bank CD 4.65 4.68 +0.03 6-month bank CD 5.34 5.32 -0.02 1-year bank CD 5.69 5.62 -0.07 2 1/2-year bank CD 5.77 5.69 -0.08 5-year bank CD 5.92 5.86 -0.06 Money market mutual fund 6.01 6.01 unch Govt.-only money mkt. fund 5.83 5.83 unch Tax-free money mkt. fund 3.68 3.23 -0.45 3-month Treasury bill 6.37 5.94 -0.43 6-month Treasury bill 6.34 5.91 -0.43 1-year Treasury bill 6.15 5.61 -0.54 2-year Treasury note 5.87 5.32 -0.55 5-year Treasury note 5.78 5.13 -0.65 10-year Treasury note 5.74 5.17 -0.57

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Source: Imoneynet.com, Reuters

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SAFE HAVENS

Money market funds may still make sense for many investors. C6

* E-BROKE?

Yields paid by online brokers’ cash accounts can be paltry. C6

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Down We Go?

Yields on money market mutual funds this year reached their highest levels since 1991 as the Federal Reserve tightened credit. But if the Fed now begins to cut short-term interest rates, money fund yields will follow.

Average simple seven-day yield on money market funds, quarterly and latest

Monday: 6.01%

Source: Imoneynet.com