The yield on the 10-year Treasury note is approaching 4 percent and can easily look appealing to fixed income investors. Treasuries provide safety from stock market volatility, but they come with risks of their own. While the yield may look good in the midst of this long drought, the risks should be weighed before buying an investment that may have a temporary halo.
If you buy an individual 10-year Treasury note, you’re making a long-term commitment. Sell it before it matures and you risk not receiving the full par value.
If you have a specific financial goal 10 years down the line where you know you’ll need a certain sum of money, a long-term Treasury may be the right investment. But if you’re looking for income, consumers usually fare better with shorter-term options ranging, perhaps, up to five or even seven years. Shorter maturities lessen the risk that you’ll be stuck with a low yield when rates rise.
Inflation appears tame now in an overall sense, although it probably isn’t if you have kids in college or medical bills. While many economists are predicting that inflation will remain under control for the rest of the year, perhaps longer; assuming it will stay dormant for the next several years seems a stretch.
“From our standpoint, as a firm, we’re not recommending that anybody go beyond two to three years in duration,” says Edward Gjertsen, Certified Financial Planner and vice president at Mack Investment Securities in Glenview, Ill. “There’s so much liquidity out there that we think the Fed is going to have to do a fine balancing act of reining in the money velocity running through the system and yet making sure they don’t put the brakes on too early and quash the recovery.”
Given the stock market roller coaster ride for the past decade, Gjertsen says it’s easy to understand why consumers crave an investment that will give them their money back. But, he says, it’s a short-sighted view that can further damage a portfolio.
“There are other solutions for individuals who want (to generate income). They can use laddered CDs or intermediate exchange-traded funds or mutual funds,” Gjertsen adds.
Marilyn Cohen, president and CEO at Envision Capital Management in Los Angeles, says she’d look toward corporate bonds.
“There are so many other bonds, certainly not as pristine in credit quality but that will give you a better yield and you don’t have to go out 10 years. Every time there’s a horrific news headline, people and institutions get scared and buy Treasuries. But people should find value elsewhere in good quality corporate names that they can count on, and maybe five- to seven-year paper, not 10-year.
“Johnson & Johnson isn’t setting the world on fire but I don’t think you’ll blow up with it either. A J&J bond that matures in 2013 is AAA rated and yields roughly 2.5 percent. Compare that with a 2013 Treasury that’s yielding 1.9 percent. Certainly you have an incremental yield over the Treasury and it’s a good name in terms of liquidity. You don’t have the state tax exemption, so if you do this you’d buy it in a tax-deferred account.”
Cohen says it’s possible to gain yield by going down the food chain in credit quality as long as you stick to good names. She suggests having an adviser find appropriate bonds or, if you’re willing to do the homework, explore the Securities Industry and Financial Markets Association’s Web site Investing in Bonds.
Cohen also still likes municipal bonds.
“They’re not as cheap as they were at the beginning of the year. But the one thing you can absolutely count on with this (White House) administration is higher taxes. Most states have already raised their state tax rates. Interest rates can go up, down or sideways and you’re still going to be clocking that tax-free interest income if you buy municipal bonds in your state. But stick with general obligations in big essential services — water and power — huge issues that are the state’s top priority when it comes to payments.”
If CDs, perhaps in the form of a CD ladder as Gjertsen suggests, are a better fix for your risk tolerance, check out Bankrate’s high yield tables. As of this writing, you could set up a five-year ladder with these yields:
A year from now, when the one-year CD matures, you’ll roll that money over into a new five-year CD, presumably at a yield considerably better than 3.5 percent. Let’s hope, anyway.