Dear Money Matters,
We're both retired. We have our life savings invested in money market funds. The return is incredibly low these days. Can you recommend some alternatives? -- DeEtta
Your comment about the meager returns of money market funds is the understatement of the day. A glance at recent returns bears that out. Conventional money market funds are paying just over 2 percent, while so-called "high yield" money markets are kicking in at about 2.5 percent.
That said, however, what ultimately is your best option depends in large part on your circumstances. If you were blessed enough to be able to retire young, you would want to consider a higher-return, higher-risk environment, such as the stock market because you would need to have your nest egg last for many years. I'll assume, however, that you're in the same boat as most retirees: You want to get the best return you can without risk.
Here are some of the most-available low-risk alternatives to money markets:
Certificates of deposit. They are savings contracts in which you lock up your money for a specified period in return for returns that are somewhat better than money markets. A one-year CD is paying a little better than the high-yield money market and, the longer you can commit to a CD, the better the rates. To see current rates, use Bankrate's CD search engine.
The downside to these slightly better rates is that you have to leave your money alone for the specified life of the CD. Withdraw it early, and you're smacked with early withdrawal penalties. One way around this is to set up a "ladder" of CDs in which you invest money in CDs with various maturities. That way, you gain access to your money as they mature in sequence, providing you with a steady stream of cash.
Another option is that piece of paper so commonly thrust into the hands of new graduates -- the savings bond. The good news here is that savings bonds are not as stodgy or as limited as they might seem. Savings bonds are issued by the U.S. Treasury Department. Available bonds include I Bonds and Series EE Savings Bonds, which are accrual securities. The Series I bonds have a compound rate that includes a fixed rate and a semiannual inflation-adjusted rate. They earn interest monthly at a variable rate, and the interest is compounded semiannually. The Series EE bonds are now fixed-rate bond pegged to the 10-year Treasury average for the preceding month with adjustments made for features such as tax deferral..
By contrast, Series HH Savings Bonds are known as "current income securities." You receive your earnings semiannually, and you receive the face value of Series HH Savings Bonds when you redeem them. Unfortunately, the Series HH bonds are no longer available as of Sept. 1, 2004.
Savings bonds offer several advantages that may appeal to you. For one thing, they're absolutely safe because they're backed by the government. They're also exempt from state and local taxes (federal taxes are deferred until you cash out the bond). Additionally, their payback is also reasonable -- I bonds (which are geared to the inflation rate) are now paying about 4.8 percent. EE bonds are at 3.5 and HH bonds check in at 1.5 percent.
On the downside, bonds have some liquidity issues. First, you cannot redeem them for the first 12 months after you bought them. Although you can cash them in after that, I Bonds or Series EE Savings Bonds carry an early redemption penalty -- equal to the last three months of earned interest -- if you redeem them earlier than five years from the issue date.
For further information on savings bonds, check out U.S. Savings Bonds Online.
Yet another option is a close relative to savings bonds -- U.S. Treasury bills, notes and bonds. These, too, are sold by the feds. Treasury bills (or T-bills) are short-term securities that mature in one year or less from their issue date. You buy T-bills for a price less than their face value; you receive their face value when they mature. Treasury notes and bonds are securities paying a fixed rate of interest every six months until they mature; then you get the face value. Their major difference is maturity. Treasury notes mature anywhere from two to 10 years. Bonds, on the other hand, mature between 10 and 30 years. The U.S. Treasury Department stopped issuing Treasury bonds (or T-bonds) in Oct. 2001.
The major differences between U.S. Treasury products and savings bonds is that you can buy and sell them on a securities' market (not so with savings bonds). Savings bonds are also a form of paper security, while treasuries are purely electronic. Finally, treasury products carry a minimum investment of $1,000. Savings bonds, on the other hand, go for as little as $25.
One of the most significant advantages to Treasury products is the range they offer, which makes it easy to identify the sort of investment that meets your needs. For instance, a recent T-bill sale featured bills maturing anywhere from 28 to 182 days (with a return of about 2.59 percent and 3.17 percent, respectively). For higher returns, have a look at Treasury notes -- for instance, a recently issued two-year note checked in at 3.65 percent.
Treasury bills and notes are regularly sold at auction. For information on when auctions are held and the mechanics of placing bids, contact a nearby a Federal Reserve Bank, a financial institution such as a bank or a government securities broker or dealer.
A great source of information on treasuries is TreasuryDirect.