For those living on CDs, Fed cuts drawing blood


Those living on interest income losing ground with Fed rate cuts

September 23, 2001|By EILEEN AMBROSE

FOR SOME, the Federal Reserve couldn't cut interest rates fast enough this year to prop up the weakening economy. But for conservative investors relying on interest income, each rate cut was likely greeted with a moan of "Not again."

Last week, the Fed cut interest rates for the eighth time this year after terrorist attacks in New York and Washington. That means another drop in the rates of short-term certificates of deposit and money market accounts.

A year ago, rates on certificates of deposit were near a five-year high, with the average yield on a one-year CD at 5.66 percent, reports, an online financial research firm in Florida.

People reinvesting that maturing one-year CD are doing so when rates are at seven-year-lows and the average one-year CD is paying 3.19 percent.

That's tough for those living on fixed incomes, who tend to be older and retired.

"Fixed-income investors might feel like they are getting pushed to invest in riskier investments. They feel like they don't have a choice," said David Berman, a financial planner with Berman Financial Group in Timonium.

"It's very similar to sitting at a blackjack table in a casino. You sit down with $500 and lose $400. You sense you have to put more on the next couple of hands to win it back," he said.

Experts said fixed-income investors don't have to take a high-stakes gamble to beef up income. But if they are willing to take on more risk, there are options that provide more income. Among them:

Real estate investment trusts that own and often manage real estate properties, including hotels, apartments, shopping malls and office buildings. Because REITs must distribute 90 percent of their taxable income each year to shareholders, they tend to have high dividends.

A high-quality REIT on average has an annualized dividend yield of about 5 percent, Berman said. He warns against REITs offering double that because they tend to be highly leveraged or have riskier properties.

Investors wanting greater diversification in REITs - say, they don't want a hotel REIT when the vacation industry is in the tank - should consider a broad REIT index fund, said Joel Ticknor, a financial planner with Ticknor Financial Inc. in Reston, Va.

REITs are not risk-free, and investors should be aware that their principal is not guaranteed.

Corporate bonds, offering higher returns than Treasuries. A 10-year U.S. Treasury bond has a yield of about 4.7 percent, a percentage point lower than that of a high-quality 10-year corporate bond, said Christopher Genovese, vice president of fixed income trading with Sterling Resources Inc. in Melville, N.Y.

It can take tens of thousands of dollars for investors to buy enough individual corporate bonds to provide adequate diversification, Genovese said. Those with less cash can invest in corporate bonds through mutual funds, which also offer professional management, diversification and easy entry to and exit from the market, he said.

Companies with lower credit quality offer "junk" bonds that promise higher yields. The risk is higher, too.

Some experts advise against such bonds, particularly for small investors, because the shaky economy increases the chance that an issuer will default and investors will lose their principal.

If investors, cognizant of the risk, still want junk bonds, experts recommend investing in them through a mutual fund that owns many bonds. That way if one company defaults, the damage is less.

When buying a bond or bond fund, stick with short- and intermediate-term issues, which are less adversely affected by rising rates than are long-term bonds, Ticknor said.

Also, choose bond funds with low expenses, because fees can easily erode returns, he said.

Preferred stock, a hybrid of a stock and bond, which generally offers a fixed dividend that is paid before dividends to shareholders of common stock. If a company goes bankrupt, the claims against assets of owners of preferred stock are ahead of the claims of those who own common stock and behind those of bondholders.

Preferred stocks are liquid and less volatile than common stock, although not every company offers them, Ticknor said. High-quality preferred stocks pay dividends of about 7 percent, he said.

"You don't buy them and trade them like stocks. You're buying them for yield," Ticknor said.

Like bonds, some preferred stocks have a "call" feature, Ticknor said, which means the companies have the option of cashing out investors in, say, five years. Companies usually do so if the interest rate falls and they don't want to continue paying a high dividend.

Agency bonds, from quasi-governmental agencies such as Ginnie Mae, Fannie Mae or the Federal Home Loan Bank.

Individual bonds might require an initial investment of $10,000 to $25,000, but small investors with less money can buy mutual funds that invest in those bonds, Genovese said.

Recently, investors have been pouring dollars into Ginnie Mae mutual funds, which offer about a 6 percent yield.

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