Take Long View of Short-Term Bonds
Low interest rates may be a boon to borrowers, but they’re a bust to retirees such as Northern California resident Larry Miller.
Miller, who has been retired for three years, has cut back on dinners out, largely because his portfolio yields about $300 a month less than it used to. Millions of retirees have similar complaints.
Income-producing investments such as certificates of deposit, money market funds and Treasury bills are paying historically low rates of return--1% to 3% annually. After management fees, taxes and inflation, some fixed-income investors are losing money on their holdings. Longer-term bonds and CDs pay a bit more, but present significantly more risk.
And investors in search of higher income face something of a lose-lose situation over the next several months, experts say.
If the Federal Reserve holds fast to today’s rates, yields on relatively low-risk investments such as money market funds will continue to languish. If the Fed decides to raise interest rates--which many analysts think will happen this year--money market yields will rise and bond and CD investors will get more for their newly invested cash. But bonds and bond mutual funds they already own probably will decline in value, because existing fixed-income securities generally lose value when interest rates rise.
“Individuals who go into bonds need to realize that there is some market risk involved,” said Denise J. Leish, a financial planner with Money Plans in Silver Spring, Md. “Interest rates are going to mostly be working against you rather than for you.”
Long-Term Bonds
Are Risky Now
What’s a fixed-income investor to do? Go short. Think munis and agencies. And get realistic about yields.
“If you can get [a total return of] 5% to 6% in a bond fund, you should be very happy with that,” said Mark Kiesel, executive vice president and portfolio manager at Pimco Investments in Newport Beach. Total return is interest income plus any price appreciation.
Possibly the most important thing investors should remember is that it may be tempting to pick up long-term bonds because they’re yielding significantly more than short-term bonds right now, but it’s also very risky.
“We are in a recovery, so the possibility of rates going higher is good,” said Dave MacEwen, chief investment officer of fixed income at American Century Investments in Mountain View, Calif. “I encourage people to stick with maturities of five years or less.”
For example, the value of a 30-year Treasury bond falls about 12% for each percentage point that market interest rates rise, Kiesel said. Shorter-maturity securities, such as five-year Treasuries, also get hit, but less dramatically. The five-year Treasury loses about 4% of its value with each one-point rise in market interest rates, he said.
MacEwen and Kiesel believe the best investments in today’s fixed-income environment are mortgage-backed securities, or agencies.
Mortgage-backed securities--largely forgotten in better times--are mortgages pooled by one of several quasi-governmental agencies such as the Government National Mortgage Assn. (Ginnie Mae), the Federal National Mortgage Assn. (Fannie Mae) or the Federal Home Loan Mortgage Corp. (Freddie Mac). These organizations put together loans with similar interest rates and maturity dates and sell them to investors. The government guarantees the principal of the loans, so there’s no risk of default.
However, when interest rates are falling, individuals whose home mortgages were sold into these pools often refinance. That causes investors to get back principal when they’d rather collect relatively high yields on their invested cash. But if interest rates rise, homeowners keep their lower rates--assuming they have a fixed-rate mortgage--while investors are stuck with 30 long years of relatively low returns.
But in a market where interest rates probably will move modestly, mortgage-backed securities pay fairly generous annual returns--about 6% to 6.25%--with little volatility, MacEwen said.
Investors who are in high tax brackets also should consider municipal bonds, or munis, he said. Although the yields on munis are modest--4% to 5%--they are exempt from federal tax. (If you buy a muni issued by your state of residence, it’s also exempt from state income tax.) For those in the top tax brackets, that makes the taxable equivalent yield--the amount you’d have to earn on a taxable investment to take home the same return after tax--attractive.
American Century’s national intermediate-term muni fund yields 4.05%, which equates to a 6.6% taxable equivalent yield for someone paying the top federal rate, MacEwen said. The company’s California intermediate-term muni-bond fund yields a little more--4.26%, which works out to a 7.65% taxable equivalent yield for someone in the top California income bracket.
Kiesel also likes bonds issued by major European governments. The interest rates are comparable to U.S. government bonds. The kicker is that Kiesel believes currency swings in the near future probably will work in the international investor’s favor. The reason: He believes the dollar will continue to weaken versus the euro. For Americans, that would mean European investments would be worth more when converted back into dollars.
Tough to Find Good Buys in Today’s Market
But if the dollar strengthens, the currency conversion would work against U.S. investors. And buying foreign bonds isn’t easy, so investing in them is best done through mutual funds.
Leish recommends dividend-paying stocks, figuring that investors get income from the dividends along with possible share price appreciation. But she acknowledges that it’s getting tougher and tougher to find good buys in today’s market.
“There are not a lot of home runs out there,” Kiesel said. “This is not going to be a home run decade for investors. You just have to try for singles and hope you can keep a high batting average.”
Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristo f @latimes.com. For past Personal Finance columns visit The Times’ Web site at www.latimes.com/perfin.
