Stunned by the stock market's historic crash this week, thousands of small investors have rushed to put funds into what they consider to be safer, less volatile bond and savings investments.
But some of the alternatives that people think are stable in fact are quite volatile. Here are some questions--and answers--on how to navigate through these alternative investments.
Q: What are the safest bond and savings investments?
A: If you define safety as protection from loss of your initial investment, the safest investments include U.S. savings bonds, insured savings accounts and money-market mutual funds.
Q: Aren't government securities such as Treasury bills, notes and bonds also safe?
A: They are, but only in so far as the Treasury guarantees the interest and payment of face value at maturity.
But Uncle Sam does not guarantee that the values of Treasury securities will stay the same before maturity. And in fact, prices of longer-term government securities can rise or fall in value quite violently--falling if interest rates rise, and rising if interest rates fall.
In some cases, bonds have declined or risen in value more than stocks. For example, if you bought a 30-year Treasury bond in March and tried to sell it in September, you would have gotten as much as 23% less for the bond, because interest rates rose sharply in that period. That 23% decline far offset the yield you would have earned from the bond.
So when you hear that a bond is government guaranteed, that most likely means the government is guaranteeing the interest payments and the face value when the bond matures. Uncle Sam does not protect you from price fluctuations in the meantime.
Q: How do I avoid such risk of price fluctuations in bonds?
A: Stick to short-term maturities. Six-month Treasury bills, for example, hardly fluctuate in price. Money-market funds also don't fluctuate because they invest in very short-term credit instruments such as Treasury bills, short-term bank certificates of deposit and corporate debt.
Q: What if I think interest rates will decline?
A: Then invest in long-term maturities. Many investors made a mint in long-term Treasury bonds between 1982 and 1986, when interest rates fell dramatically.
Q: Is there anything that will give me high yield with low risk?
A: Unfortunately, there is no free lunch, at least not in fixed-income securities. Generally, higher yields comes with higher risk. Thirty-year Treasury bonds on Friday yielded about 9.1%, more than the 5.58% on three-month Treasury bills and 5.9% on six-month bills. But 30-year bonds these days are far more volatile in price than three-month or six-month bills.
Q: How do I buy Treasury securities?
A: Treasury bills, which mature in three or six months or one year, are available from Federal Reserve banks or branches for no sales charge or from a bank or broker for a fee of as much as $50. You buy them at a discount from face value, with the minimum investment set at $10,000.
Treasury notes that mature in less than four years are available for as little as $5,000, but those maturing in more than four years can be bought for $1,000. Treasury bonds, with maturities as long as 30 years, are available for as little as $1,000.
Q: What if I want a diversified portfolio of bonds, but only have a little money?
A: Buy shares of bond mutual funds. For the small investor, these are superior to buying individual securities. By pooling your funds with other investors' money to buy a diversified portfolio of securities, mutual funds provide convenience, professional management and diversification for initial investments as low as $250. You can't get that kind of diversification by investing that amount on your own.
Also, mutual funds offer variety. You can buy shares of funds investing in government securities, tax-exempt municipal bonds, corporate bonds and the like. Many funds also offer you a choice of maturities, so if you want to avoid risk you can invest in funds that invest in bonds with shorter maturities. Money-market funds have the shortest maturities.
Mutual funds also offer the chance for better returns than most CDs and savings accounts, with better access to your money without penalties.
Q: What are the benefits of money-market funds?
A: Money-market funds are one of the best places to park money while you wait for better opportunities in the stock or bond markets. They now yield an average of 6.7%, higher than most bank savings accounts. And you can invest in some funds for as little as $500, with the convenience of writing checks against your account.
Also, many companies that offer money-market funds allow you to transfer your funds into other mutual funds they operate. Thus, if you think a new bull market in stocks has arrived, you can transfer your money from a money-market fund to a stock fund, and vice versa when the stock market goes down.