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Ask Dr. Don
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Safe fixed-income investments

Dr. Don,
Where are seniors living on fixed incomes best investing their money for both income and safety of principal at this time?

We own two bond mutual funds, Janus Flexible Income and Oppenheimer Senior Floating Rate C, that have each lost one third of their value in the past 12 months, while the needed dividend checks shrink proportionately too!

The Janus Flexible Income investment is particularly painful because it is in a 401(k) account. And since I no longer work, I can't replace the lost value, and I am at an age where I am required to withdraw a certain amount annually.
Help@70!
Barb Bonds

Dear Barb,
When investing in bonds you need to remember these two maxims:"When interest rates go down, bond prices go up" and, the converse, "When interest rates go up, bond prices go down." Interest rates have been trending lower since the Federal Reserve Board started lowering short-term interest rates in January.

Your bond mutual funds haven't turned in the performance that you claim over the past 12 months. In fact, the Janus fund has done quite well, yielding more than 10 percent on a total return basis.

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The Oppenheimer fund hasn't done as well, in part because it invests in floating rate notes, which won't appreciate in price in a lower interest rate environment and in part because it invests in high yield or non-investment grade notes.

The Oppenheimer fund is also a very expensive fund to own with an annual expense ratio of 1.38 percent as shown in the table below. You'll also pay a deferred sales load if you sell the Oppenheimer shares within one year of their purchase.

Oppenheimer Senior Flt. Rate C

Janus Flexible Income Fund

BB rated investments

62.00%

AAA rated investments

31.0%

B rated investments

18.10%

BBB rated investments

25.0%

BBB rated investments

9.40%

A rated investments

16.0%

Turnover

 N/A

Turnover

173%

Annual Expense Ratio

1.38%

Annual Expense Ratio

0.78%

One Year Return

-0.93%

One Year Return

10.40%

YTD Return

-1.95%

YTD Return

7.74%

Average Credit Quality

 BB

Average Credit Quality

A

Average Duration

 N/A

Average Duration (years)

5.7

Seniors are often attracted to high-yield bond funds because they are searching for investments that have high income streams. Keep in mind that high-yield bonds used to be called junk bonds.

The bond rating agencies rate bonds based on their creditworthiness. Anything rated below "BBB" or "Baa" is considered to be non-investment grade. The lower the credit rating, the higher the interest rate on the bonds.

That's because you're being compensated for taking on the additional credit risk. Credit risk means the possibility of default or bankruptcy. You won't earn high yields in a high-yield fund if the fund's investments start defaulting on interest or principal payments.

The paradox in looking for high income and low risk is that investments with less risk pay a lower return. U.S. Treasury securities and insured CDs are two of the least risky investments, but you won't earn much income off these investments in the current interest rate environment.

Investing in long-term maturities will let you pick up some return, but you run the risk of being "long and wrong" if interest rates start heading higher. That's because bond prices go down when interest rates go up. I've shown a middle ground using five-year maturities in the table below:

Selected Yields

Rate

Source

5-year CD

5.40%

Bankrate.com

5-year US Treasury Note

3.83%

Bloomberg.com

5-year AA Corporate Bond

4.48%

Bondsonline.com

5-year A Corporate Bond

5.22%

Bondsonline.com

From the table it's pretty clear that the CDs are the way to go for intermediate term, safe investments. Whether they are right for you is hard to determine, since you haven't disclosed how much money you have invested in these bond funds, how big a part these funds play in your overall portfolio, or your need for income in retirement.

You shouldn't look at your investments piecemeal, since it's all your money. You need to consider how your investments interrelate and how they will work together toward meeting your financial goals.

It would be a great idea for you to meet with a fee-only financial planner and discuss how your investments can better meet your retirement goals. The CFP Board of Standards can help you find a planner in your area.

-- Posted: Nov. 1, 2001

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