A common complaint among many more-conservative clients is that with interest rates near zero, investors can’t get any return on their money when they’re trying to guarantee the return of their money.
Here are the pluses and minuses of several different investment options that offer relative safety and liquidity, with fairly high interest rates and more certainty and transparency than what bond mutual funds can provide.
CDs
You can’t beat certificates of deposit for safety and certainty. But with average rates on even long-term CDs hovering near 0.25%, you’re going to have to dig to find something attractive.
Brokered CDs at your firm or custodian offer the convenience of keeping the assets in-house but have two distinct disadvantages: The yields usually aren’t competitive, and if the clients want to cash out of the CD before the maturity date, they will be forced to sell it at market prices (which if rates rise in the meantime, could be much lower than the CD’s face value).
CDs at other outside banks or credit unions can pay much more, and usually have a limited and fixed penalty for early withdrawals (such as a loss of six or 12 months’ worth of interest).
You can search sites like DepositAccounts.com and BankRate.com for some of the higher-yielding CDs around the country.
Bank Money Market Accounts
While searching for CDs, you might find a few banks offering higher-yielding FDIC-insured money market accounts with tempting yields of 0.50% or more.
But, interested clients should consider a few things before moving any money to these accounts. First, those rates usually aren’t guaranteed for any duration and could drop back to zero at a moment’s notice.
Second, there may be conditions required to earn that promotional rate, such as opening a checking account and using a corresponding debit card for a minimum number of times per month.
Finally, the “no free lunch” rule applies here as well. The high rate may be a teaser to sell depositors other financial products and services that are more profitable for the institution, and perhaps less so for the client.
Municipal Bonds
According to FMSbonds, at the time of this writing, the sample AAA-rated 20-year tax-free municipal bond paid 1.20%.
That might not seem like much, but for an investor in the 35% federal income tax bracket, it’s the equivalent of getting about 1.85% on a fully taxable bond. That’s about 35 basis points more than what a similar (albeit safer) 20-year Treasury bond pays.
And the safety of municipal bonds is something that investors should consider before allocating assets in the direction of tax-frees.
Rising interest rates will of course erode the market value of municipal bonds, even if income tax rates rise or remain the same.
Worse yet, the pandemic and recession have severely reduced the amounts of tax and other revenue that most municipal bond issuers use to pay interest to bondholders, to say nothing of the more-crucial principal at maturity.
Finally, municipal bonds are relatively thinly traded, so unless clients have a substantial amount to invest and can hold the bonds until maturity, any interest or tax advantage can quickly be eroded by the difference between the bid and the ask.
Stable Value Funds
Clients who have assets in or access to an employer-sponsored retirement plan may have an investment option that you can’t offer: a stable value fund (similar to guaranteed investment contracts).
These fixed-rate accounts are often sponsored by an insurance company or other financial institution, and usually available only in 401(k)s, 403(b)s, etc.
The interest rates usually exceed the yield offered by certificates of deposit and are usually fixed for a certain period, such as a given quarter or calendar year.
Stable value funds and the like strive to maintain preservation of principal, and in the past these accounts have generally been able to uphold that obligation. Though that’s no guarantee they will be able to do so in the future.
And the security behind the backing is the value of the underlying investments, and perhaps insurance provided by the sponsor—not the FDIC or any other government insurance.
Even if a loss is unlikely to occur in stable value accounts, clients should be aware of potential devils in the details. Understandably, language in the prospectuses of these investment vehicles allows sponsors to temporarily suspend withdrawals and/or deposits in times of crisis.
Depending on the sponsor and the employer, transfers to and from the accounts may be limited to certain windows of time, and direct movement of money from stable value funds to competing funds (such as money markets or short-term bond funds) may not be allowed.
If a client has assets in both an employer-sponsored plan and under your management, it may be advisable to use the stable value account for some or all of the money in the at-work plan, and then complement that investment using the assets you manage.
Savings Bonds
Good old government savings bonds aren’t just gifts from Grandma anymore. The Series I version currently pays 1.68% annually on new bonds bought before May 1, 2021. The rates adjust with the Consumer Price Index every six months.
Better yet, that yield is exempt from state taxation, and owners can choose to either declare (and pay taxes on) that interest annually, or upon the bonds’ maturity in 30 years.
There is a penalty of three months of interest on bonds redeemed within the first five years of ownership, and no penalty for early redemption after that.
Now for the drawbacks. Individuals can purchase only a maximum of $10,000 per person per year (although they can use their federal tax refunds to buy up to an additional $5,000 annually). And they can’t be purchased in tax-sheltered retirement accounts, such as IRAs.
Clients can’t just waltz into their local bank to purchase savings bonds, however. They have to go through a somewhat arduous process of opening and funding an account at TreasuryDirect.gov.
Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of Make Your Kid a Millionaire (Simon & Schuster).
