Fed rate cuts hurt small investors Modest returns from CDs, money market funds shrink.

July 06, 1992|By Allen R. Myerson | Allen R. Myerson,New York Times News Service

Stubbornly conservative investors found that their scant returns from money market funds and CDs shrank more last week after the Federal Reserve cut two key interest rates. Financial strategists are telling them that they must take more risks to get higher returns.

But with the economy wheezing and many securities already high priced, these advisers say, Janus-like, to take risks cautiously. Buy bonds with longer maturities, but not too long, they say; invest some money abroad -- but not too much; buy some stocks -- but not the risky or overheated kind.

Reports of rising unemployment and the Fed's quick response last week left many risk-free investments paying too little even to keep up with 3.5 percent inflation. Shorter-term interest rates -- reflected in money-market funds, savings accounts and certificates of deposit -- have plunged to 20-year lows. The most timid investors are earning less than half as much income as two years ago.

Kenneth B. Herz, a spokesman for Chemical Bank, bashfully cited a savings account rate of 3.05 percent, the same as for six-month certificates of deposit. "Lower than I ever thought I'd see as a child of the 80s," he said. He quickly listed some of the stocks, bonds and mutual funds that Chemical offers as alternatives.

Ian A. MacKinnon, who manages fixed-income mutual funds at the Vanguard Group, said he was pleased that customers fleeing low rates were generally taking his advice to stick with short- and intermediate-term investments.

In 1987, he said, yield-seekers flocked to longer-term funds. When the credit markets turned against them in April and August, he said, "They got clobbered."

Many analysts now predict that if the recovery gains any strength, interest rates will bounce back up, and since principal and yield move inversely in the credit markets, that means the value of outstanding issues will drop.

Vanguard's long-term Treasury bond fund yields 7.61 percent, but it will lose 9.5 percent of its value if interest rates rise 1 percent.

Shorter maturities gain more in safety than they give up in yield, Mr. MacKinnon said. The intermediate-term Treasury bond fund, yielding 6.74 percent, would lose only 5.6 percent of its value, and the short-term fund, yielding 5.19 percent, would lose 2.6 percent.

Even many stocks and stock funds yield more than money market funds and CDs. But mutual funds report that investors in stock are becoming more careful. "People are getting more pessimistic about the economy," said Neal Litvack, senior vice president of marketing at Fidelity Investments. "If they do come back in, I expect they will skew to the very conservative end of the stock spectrum."

Many strategists advise seeking stocks and funds for which value is based more on a reliable yield or financial strength than on hopes for a brisk recovery.

"If you're going to be in the equity market, you had better be sure you're looking at a darned strong balance sheet," said Charles Allmon, editor of the Growth Stock Outlook newsletter. Among his favorites are utility stocks.

Mr. Litvack recommends income funds, which aim more for high dividends than growth. The Fidelity Balanced Fund, with 60 percent stocks and 40 percent bonds, yields more than 5 percent.

Early in the year, he said, many investors were choosing riskier investments -- cyclical stocks, smaller companies, sector funds. Since then, he said, they have had so little appetite for risk that they have invested $600 million more in the Balanced Fund, leaving it with $1.3 billion.

Those searching for higher yields than virtually anything but junk bonds offer in the United States can look abroad. Fidelity's World Income Fund invests mostly in short-term foreign securities, with a 9.2 percent yield.

Several banks offer CDs in foreign currencies. Mark Twain Bank of St. Louis has them from at least a dozen countries. Six-month CDs from Germany yield 8.75 percent, from Britain and France 9 percent.

Foreign investing carries the risk exchange rates could turn the wrong way, more than swallowing any extra interest. Mark Twain Bank tries to discourage smaller investors by demanding a minimum of $20,000 for its foreign CDs, and advising them to invest no more than 15 percent of their money.

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