Choice of savings vehicle hinges on why the money is being saved


October 20, 1991|By JANE BRYANT QUINN | JANE BRYANT QUINN,1991, Washington Post Writers Group

New York -- Savers weeping over their low returns in money-market mutual funds and certificates of deposit are moving their cash into higher-yielding bond mutual funds.

But should they? The two types of investments serve different purposes. A CD investor isn't necessarily the right person to plunge into a bond fund.

In deciding whether to make the switch or to leave your money where it is, you first have to ask yourself, "What am I saving this money for?"

* Is it ready cash? Then it should stay in a passbook account (paying about 5 percent), bank money-market account (current average: 4.85 percent) or money-market mutual fund (5.21 percent). Forget that interest rates are low. In real terms, they always were. When money funds paid 9 percent, inflation was much higher, too.

You use these accounts for a combination of safety and access. But, because they pay such low real rates, you shouldn't keep any more cash there than you need at hand.

* Is it cash you'll need within three or four years? That, too, should stay safely in the bank. In this category, I'd put money you're saving for a down payment on a home, college tuition due soon and retirement cash that you'll need to pay bills.

You can't afford to lose this money, so it should stay in insured investments. But you needn't accept passbook rates. A one-year certificate of deposit averages 5.55 percent. A 2 1/2 -year CD is at 6.06 percent. Buy a CD that will mature on the date you'll need the money.

* Is it cash that you won't need for five years or more? That could be put into higher-rate investments, such as bond mutual funds. The Investment Company Institute reports that $390.5 billion has been invested in such funds this year.

But mutual funds carry greater risks. So the next question you have to ask yourself is what kind of risk you are able to take.

With bond funds, there's no maturity date as there is with certificates of deposit. So there's never a day when you can count on getting all your capital back. You buy shares in the bond fund; the value of those shares fluctuates, depending on what's happening in the market.

When interest rates fall, as they have been lately, the price of your bond-fund shares will rise. When interest rates rise, as they indubitably will, the price of your bond-fund shares will fall.

Bond funds are terrific for speculators who are betting that interest rates will decline. If that happens, they can sell their shares for a capital gain. Bond funds also make sense for investors in corporate bonds or high-yield, or "junk," bonds, who need a lot of diversification.

But bond funds are poor bets for people who don't want to risk losing money. The interest paid by bond funds will cushion any loss. But in a climate of rising rates, the value of your fund will drop. If you have to sell, you may come up short.

Cautious investors might risk a short-term bond fund, whose bonds generally mature in less than three years. The price of these funds doesn't fluctuate much. But most investor money today is flowing into the longer-term funds whose prices bounce around a lot. That could be a shock for investors used to stable CDs.

Happily, there's an alternative for CD investors who want higher rates but also want every dime of principal back. You can buy individual bonds and hold them to maturity.

A five-year Treasury note currently yields close to 7 percent; a 10-year bond, nearly 7.5 percent. Minimum investment: $1,000. You can buy them free through any Federal Reserve bank or branch.

For tax-exempt investments, buy individual municipal bonds. Minimum investment: $5,000. Ideally, you should have at least five different issues for diversification. But if you buy a triple-A general revenue bond (backed by taxes), maturing within five to 10 years, you're probably safe with just one or two issues. Try to buy newly issued bonds. For individuals, they usually carry the fairest price.

The key point is that you're buying these bonds to hold until maturity. So stick with five- to 10-year bonds. If you have to sell before maturity, you might take a beating on the price.

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