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Special Report: Strategies for Volatile Markets

Make Sure You Know How Long That Yield Is Good For

September 06, 1998|PAUL J. LIM

You might be able to lock in a decent yield now on guaranteed investment contracts or other stable-value options in your 401(k) plan.

But check the fine print to see how long that yield may last.

Today, the typical GIC or stable-value fund yields around 6.5%, according to Kelli Hueler, president of Hueler Cos., a research firm in Minneapolis.

That's far more than the 5% average yield on money-market funds. It's also quite competitive with the returns on intermediate-term corporate bonds.

Fixed-rate GICs promise a set interest rate good for the life of the contract, which typically ranges from six months to about five years. Depending on how your 401(k) plan is structured, the proceeds of your GIC, once it matures, may or may not be automatically rolled into a new contract.

Not all stable-value investments offer a fixed rate. Some contracts offer a variable rate, which could fluctuate depending on the movement of market interest rates.

And stable-value funds, which typically invest in individual GICs, usually can't tell you a specific yield you'll earn, but rather will give a tight range of yields you can expect in the near-term.

In reality, stable-value fund yields have moved very little in recent years. Karl Tourville, manager of the $2.2-billion Norwest Stable Return Fund, notes that in the last 10 years the fund's yield has stayed within a 6.45%-6.55% range.

If you decide that GICs aren't for you, and you'd rather invest in bond funds to gain some diversification away from stocks, first determine what kind of bond options your 401(k) plan offers.

Corporate bond funds will pay more than U.S. government bond funds, but that also means there is more risk in corporate funds.

Also, focus on a bond fund's term. According to mutual fund tracker Morningstar Inc., the typical long-term bond fund invests in debt that matures in about 14 years. By comparison, intermediate-term bond funds' holdings mature in around nine years and short-term bond funds' holdings mature in four years or less.

Longer-term bonds expose investors to more risk of principal value fluctuation, since they tie up money for longer periods of time. But historically, they have compensated investors for the greater volatility with higher yields--although today, in the case of Treasury bonds, long-term yields aren't much above short-term yields.

Over the last 10 years, the total return (yield plus price appreciation) on long-term government bond funds has been 115%, versus 88% on short-term government bond funds, according to investment researcher Lipper Analytical Services. High-quality long-term corporate bond funds have returned 134%.

If your 401(k) plan doesn't offer a good bond fund list--for instance, if it offers only a long-term bond fund when you want a short-term fund--you can always invest in bonds outside the 401(k).

But note: Income earned by bonds outside a tax-deferred account will be taxed at your regular income tax rate, thus reducing your true return.

For more information on bonds and bond funds, major mutual companies offer some good educational material. Try Fidelity Investments ([800] 544-8888), Vanguard Group ([800] 662-7447) or T. Rowe Price ([800] 638-5660).

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