A primer on floating-rate demand notes

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How low will you go?

These days, many people are willing to practically touch bottom, accepting just a tiny fraction of 1 percent yield on their savings.

In this precarious economy, it can make sense to accept the scant returns on federally insured bank accounts or money market funds that aren’t insured by the Federal Deposit Insurance Corp., but which invest in U.S. Treasuries and other highly secure products.

But not everyone is satisfied with the low-yield environment, “where even one-quarter of 1 percent is high,” says Brad Reynolds, financial analyst with LJPR LLC, a wealth management firm in Troy, Mich.

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More investors are being drawn to a relatively obscure instrument of the investment world called floating-rate demand notes. Offered directly to consumers via the websites of well-known companies, the notes are similar to a bank account or money market fund in that many programs allow investors to write checks to access funds, usually over a minimum such as $250.

Floating-rate demand notes typically pay more than savings accounts or certificates of deposit, ranging from almost 1 percent to more than 1.5 percent, with larger yields typically offered for larger deposits. They usually require a minimum investment of $500 or $1,000. There is no maturity date, and investors can sell at any time.

Some floating-rate notes are tied to the average yield of all money market funds and adjusted weekly, promising to pay at least 0.25 percent higher than the money market funds.

Corporate motive

Large firms such as Caterpillar, Ford Motor Co. and General Electric offer the notes to the public to “diversify their investor base,” says Brian Kalish, finance practice lead at the Association for Financial Professionals, a professional group for company financial officers in Bethesda, Md.

These companies also raise money for their operations by selling short-term bonds to large institutional investors or to individuals through brokers. But by selling the notes directly to consumers via the Internet, the firms can save on commission payments to brokers and also sell to individuals who tend to hold the investment longer than institutional buyers, Kalish says.

Risk and reward

The higher yields follow the old maxim: When investors take more risk, they can earn more.

“These are well-known companies, and we don’t view them as distressed,” says Brian Kazanchy, investment committee chair at RegentAtlantic Capital LLC, a wealth management firm in Morristown, N.J.

Still, “The additional yield over an insured short-term CD or savings account is not that meaningful to take on the credit risk,” Kazanchy says.

The floating-rate demand notes are not for people who have limited funds and shouldn’t be a substitute for emergency cash reserves in an insured bank account, Reynolds says.

However, for investors who understand the risk, “This could work for part of the cash portion of your portfolio,” Reynolds says.

Due diligence

Consumers should “read the prospectus (on the notes), and they should research the company and the industry,” says John Heffernan, director of corporate finance for the Charlotte, N.C., power company Duke Energy’s PremierNotes program. “We also recommend that they seek advice from a financial adviser.”

“Check the ratings on the short-term debt from the websites of Moody’s and Standard & Poor’s,” says David Sekera, a senior securities analyst with Morningstar.

Friends and family

In many cases, people hear about floating-rate notes from family or friends who work at a company offering them, says Warren McIntyre, owner of VisionQuest Financial Planning LLC in Troy, Mich.

In some cases, the notes may only be available to company employees. In others, it may be open to the public. For example, Duke Energy launched its site offering PremierNotes in the spring of 2011. “Originally, it was just for employees and retirees. Then we added shareholders and then the general public,” he says.

Familiarity with a firm may enhance your knowledge of it. But just as employees shouldn’t put too much money into their employer’s stock because they could lose their job as well as the value of their stock if the company becomes distressed, employees should be wary of allocating too much of their assets to their company’s floating-rate demand notes, Kazanchy says.