Safe Investments: Understanding CDs, Treasuries, Money Markets and TIPS
Now in January 2009, it is hard to find a safe place to invest and get any kind of return. A year ago I might have thought blue chip companies with good and safe dividends was the place, but in the past year that hasn’t been very safe. I might have thought a bond mutual fund. That doesn’t look safe anymore with the recent story about the Oppenheimer core bond fund losing some 38% in 2008 because the fund manager was using risky interest rate derivatives. After last year, there just isn’t much trust anymore in the markets.
Interest rates are very low at this time and there doesn’t seem to be inflation any time soon that would raise interest rates. With a CD you have to decide how long you want to lock up your money at a fixed rate. Anywhere from 3 months to 5 years, and are they are safe under most conditions. Make sure before you buy anything, that the bank you deal with is Federal Deposit Insurance Corporation (FDIC) insured. If the bank fails with your CD money in there, up to $100,000 will be covered by the federal insurance. This is where most people lose money, when the bank they had their CD in failed, because they were over that limit.
If you invest $100,000 in a CD and keep the interest in the bank and the bank fails, you could lose all of your interest, because the interest you earn raises you above the $100,000 limit. To get around this, have the bank mail you the interest monthly. Recently the government raised the limit to $250,000 for certain types of IRA accounts.
If you cash your CD before it matures you will have to pay a penalty, which can sometimes be hefty, so make sure you wont need this money right away.
The difference between APY and APR
Annual percentage yield (APY) is the total amount of interest you earn in one year, taking compounded interest into account. APR is the interest in one year without the interest. The more frequently interest is calculated the more the yield will be. Compounding really does work, but you don’t need to get bogged down in the math, just look at the APY and the highest APY will give you the best return. To find the best CD rates in the country or your city, go to Bankrates.com.
Building Ladders for a higher return
You can increase your return if you ladder your CDs. For example you might buy 3, 6, 12, and 15-month CDs at the same time. All maturing at the different times, you have money coming in and you can increase your returns. You can do this with the different types of safe investments such as T-bills and zero coupon bonds.
Money markets are usually invested in safe instruments such as US government Treasuries and other insured assets like corporate or municipal bonds. Sometimes the money market accounts are invested in more risky or questionable instruments, then the value could fall to less than $1, which is called “breaking the buck”. This happened in September 2008. A certain money market can then fall below $1 par value, causing a run on the money market account. So you could lose some of your money or have a delay in getting it back, but that still seems very unlikely.
With a money market account, you can usually write a limited amount of checks on it. Some banks charge a monthly service fee, cutting into your money. The pros of a money market account are that you can get your money any time you want without penalty. If you go with a money market account, make sure that money market and the bank are FDIC insured.
TIPS - Treasury Inflation-Protected Securities
TIPS provide protection against inflation. The principle goes up with inflation and down with deflation according to the CPI (consumer price index). At this time the CPI is still going down and there still is deflation. With the huge deficit and all the bailout money you might think their will soon be inflation, some say there just has to be, but it hasn’t shown up yet. You can buy TIPS starting with $100 in 5, 10 and 20-year maturities and the minimum amount is $100. They can be held until maturity or they can be sold in the secondary market.
US Treasuries are paying under 1% now, I couldn’t consider them as an investment, unless you just want a safe place to park your money.
At this time I like CDs for the best return and knowing exactly what I’m getting back and when. Money Markets are good for that emergency money. Government Treasuries pay just too little. TIPS can be something to look into once we enter an inflationary period.
Sam Montana © 16 January 2009
- Find FDIC banks in your area
- Different ways to get around the $100,000 limit
- Build a CD ladder to see how much return you can gain
- More about TIPS
- Investing in a bear market
- Basics of mutual funds