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Taking the risk out of investing

Dr. Don,
I'm new to investing and have a question about no-risk investments. Is there a no-risk alternative to CDs (certificates of deposit) that would offer a better rate of return? Is a person better off investing in short term CDs until the rate goes back up? Right now I have 33 percent allocated to stocks and 33 percent to mutual funds, and I'm looking for a safe place for my other 33 percent.
Thanks,
Kevin

Dear Kevin,
When you're talking about no-risk, you're talking about insured CDs, U.S. savings bonds or U.S. Treasury securities.

Investors don't like to be long and wrong when investing in CDs or bonds. If interest rates go higher, then they may have been better off to invest short-term and wait.

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One way to get around guessing where interest rates are going is to invest in a laddered portfolio of CDs or bonds. A laddered portfolio is the bond investor's answer to dollar-cost averaging in the stock market.

Take the money you want to allocate to bonds or CDs and invest it evenly across maturities out to the longest maturity that you are comfortable investing in. Then when an investment matures you replace it with more of the longest maturity you're willing to purchase.

For example, investing $2,000 each in one-year, two-year, three-year, four-year and five-year CDs puts $10,000 to work. When the one-year CD matures you buy another five-year CD. That way you're not trying to time interest rates and you'll get an average return over time.

For more on how to ladder a CD portfolio, see this Bankrate story.

Another way to avoid trying to guess which way interest rates are going is to buy Treasury Inflation Indexed (TII) securities or Series I U.S. savings bonds. Since changes in inflation heavily influence interest rates, buying inflation-indexed securities is a reasonable approach to managing interest rate risk. Both investments have a fixed interest component plus periodic adjustments for inflation.

The Series I savings bond is a little more consumer friendly, but the TIIs are marketable securities that you can buy and sell. TIIs are better suited to tax-deferred accounts, like an IRA account, because of how the investment returns are taxed.

When reviewing the investment allocation in your portfolio you should look at the percentage of your investments held in stocks, bonds and cash since mutual funds invest in all three. If your mutual funds are 100 percent invested in stocks then your current allocation is 66 percent stocks.

You invest to reach a future financial goal, whether that's a comfortable retirement, college funds for your children, or a new boat. The further away the goal, the more risk you can accept in investing for that goal. Consider your investment horizon when you allocate your investments.

-- Posted: Aug. 8, 2001

Read more Dr. Don columns
See Also
Financial advice glossary
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CDs and Investments
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NATIONAL OVERNIGHT AVERAGES
1 yr CD 1.00%
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