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For Income Seekers, There Are Alternatives

Unattractive returns on money market funds and high-quality bonds are prompting investors to look elsewhere.

July 08, 2002|E. SCOTT RECKARD | TIMES STAFF WRITER

After the stock market's 28-month slide, many weary investors now are much more interested in securities that generate regular income--a financial return they can count on.

But investors face a special challenge today: Yields on money market accounts are near 40-year lows, and interest paid on high-quality bonds is paltry.

The average yield on a taxable money market mutual fund is 1.33%, down from 1.59% at the beginning of the year, according to rate-tracking firm IMoneyNet Inc. in Westborough, Mass.

The yield on 10-year Treasury notes is 4.86%, down from 5.11% six months ago.

Meanwhile, investors who earlier this year took a chance on certain higher-yielding alternative investments, such as corporate "junk" bonds, have been burned.

Junk bonds have sold off sharply in recent weeks as investors decided the economy's recovery won't soon lift many of these "fallen angels."

And emerging-market bond mutual funds, the top-performing bond fund sector until a few weeks ago, recently demonstrated their classic volatility when they plummeted on fears that Brazil will elect a leftist regime that will default on the nation's debt.

As all this spurs income seekers to search far and wide for other ideas, options such as municipal bonds, inflation-indexed Treasury bonds and the "stable-value" funds found in many 401(k) plans look attractive to conservative investors, experts said.

The more risk-tolerant may want to consider high-dividend-paying stocks or mutual funds that invest in these stocks (such as real estate investment trust funds).

However, a cardinal rule of investing should remain uppermost in income seekers' minds, said Alan Papier, a senior analyst with Chicago fund tracker Morningstar Inc.: "High yield is achieved only by taking on extra risk."

The risk these days is not just of more bond defaults by shaky corporate issuers, although that's clearly a concern. There also is so-called market risk: After 11 Federal Reserve interest rate cuts last year, the next direction for rates is almost certainly up, assuming the economy continues to recover.

And when rates begin to rise, the effect will be to depress the principal value of older securities that are locked in at a lower rate--especially longer-term bonds, including otherwise super-safe Treasuries.

For income seekers, that risk means investments must be chosen very carefully. You must decide whether you can stand any risk of loss to your principal, even on paper.

Here's a look at some income-producing options other than money market funds, conventional Treasury securities and corporate bonds:

Certificates of Deposit

Although today's bank CD rates won't make anyone rich, they can keep investors ahead of inflation while they wait for better alternatives. And it does pay to shop around: For example, in Southern California recently, Kaiser Federal, a credit union-turned-savings institution, was paying about a percentage point higher on its CDs than comparable Treasury securities.

Newspapers and business publications often publish lists of high-paying bank and thrift CDs, but the most current rates are online: Bankrate.com, for example, lists top-paying institutions not only nationally but also by city and state.

Bank and thrift CDs are as safe as Treasury securities--up to the $100,000 per account limit on federal insurance. As with bonds, the longer you agree to lock up your principal, the higher the interest paid.

Recently, the highest rate on a one-year CD shown on Bankrate was 3.30% from ING Direct in Wilmington, Del. The national average on one-year CDs: 2.16%. If money market fund rates stay in their current 1.33% range well into next year--a strong possibility, many experts believe--CDs maturing in a year or less may be a better idea.

TIPS

The current 4.86% yield on conventional 10-year T-notes is at least a positive return after inflation, but that could change fast if the cost of living surges. Why can't bond returns rise along with inflation?

The answer is that some do: Uncle Sam has issued bonds that guarantee a total return--interest payments plus return of principal--of about 3 percentage points more than the change in the consumer price index over time. If inflation shot up to 6% annually, the return on these Treasury inflation-protected securities, or TIPS, would rise to 9%.

"I wish I could get every grandma in America to own these things," said Jeffery Coyle, chief strategy officer for MyCFO Inc., a Mountain View, Calif., financial advisory firm for the wealthy.

Because of their structure, TIPS are a good idea for generating income in tax-sheltered retirement accounts, Coyle said. Pimco Funds and Vanguard Group both offer large mutual funds that invest in inflation-protected bonds.

Stable-Value Funds

These funds, an option in many 401(k) plans, also are available through mutual fund companies in some individual retirement accounts and college savings plans. They usually hold so-called guaranteed investment contracts from insurance companies.

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