Financial Tips

Published 12:00 am Tuesday, January 2, 2001

Alan S. Moore

Practically every investment article you read these days mentions fixed income investments. One article will tell you to keep a balance between stocks and fixed income investments in your portfolio. Another will stress fixed income investments for the conservative investor. And still another will advise you to switch from growth-related investments to fixed income investments as you prepare to retire.
But what exactly are fixed income investments? How do they work? And why are they so important to those about to retire or to those already retired?
Safety, then, is one of the key reasons why financial advisors suggest that you lock into fixed income if youre thinking about retirement. After all, once you retire, youll be primarily spending your retirement resources. You may have limited opportunity to add to your nest egg. Here are some popular fixed income investments to consider:
Savings Account- If you keep your money in a typical savings account, the bank will pay you a certain annual rate of interest. Such accounts are ideal for small investors since there is so little risk of losing your investments because savings accounts with a covered institution are insured by an agency of the Federal Government for up to $100,000. However, the rate of inflation may outpace the interest rate of the savings account.
Money Market Account- A money market account is not literally a “fixed” income investment because the interest rate varies depending on the range of short-term government securities in which it invests. Often, though, a money market account will pay a higher rate of interest than a regular savings account and is also federally insured. However, you may have to maintain a minimum balance and meet certain minimums when making deposits and withdrawals. As long as you meet the minimum requirements, you can typically withdraw your money at any time without penalty.
Certificates of Deposit.— The interest rate on certificates of deposit ordinarily outpaces that of money market accounts and is guaranteed as long as you leave your money on deposit for a specific amount of time. If you need to withdraw your money early, however, you may face a substantial penalty. CDs, too, are insured by an agency of the federal government.
U.S. Savings Bonds— U.S. Savings Bonds are usually considered a very safe investment because they are backed by the federal government. Series EE Savings Bonds held for less than five years pay a pre-determined rate of return compounded semiannually. If you hold them longer than that, youll earn an even higher rate — 85% of the average yield on five-year Treasury securities. In addition, these bonds can be replaced for free if lost, stolen, or destroyed; they are exempt from state and local income and personal property taxes; and they may be exchanged for current-income HH Bonds for continued tax deferral on accrued interest.
Treasury Bills, Notes, and Bonds- Also issued by the federal government, these investments generally pay a higher rate of interest than savings bonds. Treasury bills mature in three-, six-, and twelve-month periods; Treasury notes mature in two to ten years; and Treasury bonds mature in ten to thirty years. Typically, the longer youre willing to commit your money, the higher the interest rate on the investment will be.
Municipal Bonds- Municipal bonds are issued by state and local governments. They usually pay a slightly lower rate of interest than federal bonds, but typically you dont have to pay any federal income tax, or in many cases, state income tax, on municipal bond interest. This feature is especially appealing to people who want to reduce their taxable income.
Corporate Bonds- These are bonds generally issued by large and mid-size corporations. As such, they may pay a higher rate of interest than government bonds, but they are also regarded as more risky since they are only as good as the company issuing them. Bonds issued by new companies or by companies that have excessive debt are often referred to as “junk” bonds. While these junk bonds carry a high interest rate, they may also carry a very high risk of default.
Should you place part of your portfolio in fixed income investments? Probably. Most professional advisors recommend some fixed income investments simply for diversification. The actual percentage, though, will depend partly on your particular circumstances and on your investment philosophy.
Alan S. Moore is a Financial Advisor of Legg Mason Wood Walker Inc., a diversified financial services and securities brokerage firm that is a member of the New York Stock Exchange and SIPC.