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Safe Investments – How Safe Is Your Money?
By Chris Duncan
After working hard to build a nest egg for retirement, you want to know that your investments provide a good return but remain safe. Although well managed stocks, mutual funds, and corporate bonds can provide superior returns, risk goes hand in hand with reward. Your principal and earnings are not guaranteed and can be dramatically affected by a down turn. As people near retirement, it makes sense to move investments into safe fixed income products such as Treasuries, Government Agency Bonds, and/or Certificates of Deposit.
Here is a safe investment guide with pros and cons for each product.
Treasury Bills, Notes, and Bonds
The only difference in the above is the length of the term. T-Bills are offered with a term length of 1-year or less. T-Notes are offered with a term length of 1-year to 10-years. Finally, T-Bonds are offered with term lengths greater than 10-years. We will collectively call these Treasuries. Treasuries are issued by the Federal Government and you are basically loaning them your funds for which they guarantee to pay you a certain interest rate. They are guaranteed by the ‘full faith and credit’ of the United States Government. You will always get your principal back at maturity. Treasuries can also be purchased in large denominations. Their safety and ease comes with a relatively low rate of return. They can also be bought and sold in the secondary market. Treasuries are a safe investment, but as with any of these fixed income investments, they do carry the risk that interest rates and/or inflation will rise during the term, thus eroding their spending power. Treasuries are exempt from state and local taxes.
Government Agency Bonds
Government Agency Bonds are issued by agencies of the Federal Government and with the exception of the GNMA (Ginnie Mae – Government National Mortgage Association) they are NOT backed by the ‘full faith and credit’ of the government. As far as safe investments go, GABs are considered next in safety to Treasuries and Certificates of Deposit. GABs carry a AAA rating, but because they aren’t backed like Treasuries and there can be a prepayment or call risk, they offer superior rates than Treasuries. A prepayment risk comes into play, if the underlying loans that the security is backed by, pay off early and thus decreases the life of your bond. GABs are usually offered with maturities from 2-years to 15-years, but have call periods where the principal can be returned to you without having to pay further interest. This is a call risk. In a falling rate cycle, your bond will most likely be called and your re-investment rate will be lower than what it was. Many people find themselves having to buy long-term bonds to try to maintain an attractive rate. In a rising rate cycle, your funds may go the life of the bond and miss out on higher rates. Many GABs are exempt from state and local taxes. Government Agency bonds can be purchased in large denominations and are considered a very safe investment.
Certificates of Deposit (CDs) Banks and credit Unions offer Certificates of Deposit for terms usually from 90-Days to 5-years. As long as the CD is offered by an FDIC insured bank or NCUA insured credit union, your principal is guaranteed by the federal government up to $250,000 for a single account; $500,000 for a joint account; and $250,000 for an IRA.
(Note: the $250,000 insurance limit is set to expire 1/1/14) If you open a CD that compounds and open it for less then the interest you will earn, the principal and interest would be guaranteed up to the above amounts. Because, they carry no risk (as noted above), certificates of deposit are an attractive and very safe investment. The interest from CDs is fully taxable. Most CDs are fixed for the term you select, but there are banks that offer callable CDs and even CDs linked to different market indices. Certificates of deposit generally offer yields that are better than Treasuries and GABs, but you may want to do a tax analysis to see what the Tax Equivalent Yield is. You can open Certificates of Deposit at multiple institutions and receive $250,000 of FDIC insurance at each institution. Searching for multiple institutions can be time consuming. Deposit brokers can assist you and save you time with this search.