In a market where prices are falling, interested investors are seeking top financial advice on where to safely place their share. Elliot Raphaelson is a former vice president of Chase Manhattan Bank who taught personal financial planning and investments at the New School for Social Research in New York. Here, he shares with Post readers five investments to consider in a bear market.
Intelligent Investing in a Bear Market
By Elliot Raphaelson
The present bear market that started in the last quarter of 2007 has been cruel to investors of all sorts, whether they are in stocks or bonds. Most have seen their investments drop by 40 percent or more, and even those with diversified portfolios have been unable to escape the damage. In reaction, many have sold their remaining assets and reinvested the proceeds into very conservative investments such as Treasury bills, money market accounts, money market mutual funds, and short-term certificates of deposit.
Such investments are considered safe from capital loss, yet the interest they provide is small in comparison to past history. Since the Federal Reserve has adopted an “easy money” policy, meaning it has made short-term interest rates low, people who put their money only into these conservative investments will probably be making returns that are less than the rate of inflation.
But there are other investments that can provide a reasonable amount of income without exposing one to undue risk. The following are five safe places to park your cash while you are waiting for the economy to turn around and interest rates to rebound.
1. GNMA Mutual Funds
While most common stocks and bonds were falling dramatically through 2008, the majority of GNMA funds provided investors with consistent monthly earnings, yielding a five percent return on an annual basis. GNMA (or Ginnie Mae) stands for Government National Mortgage Association, a U.S. government-owned corporation within the Department of Housing and Urban Development (HUD). The association provides guarantees on mortgage-backed securities backed by federally insured or guaranteed loans issued by various Federal agencies. Both principal and interest is guaranteed on GNMA funds. Mutual fund companies purchase a pool of these mortgages and offer them to the general public.
GNMA funds are considered an intermediate term investment, maturing on average in three to 10 years. The share prices of GNMA funds fluctuate daily as with all mutual funds, but the amount of fluctuation is minor compared with other types of funds. For example, in 2008 the difference between the high and low price for Vanguard’s GNMA fund was less than 6 percent. Over the past 10 years, the vast majority of GNMA funds had positive results each year with average returns of more than 5 percent.
2. Intermediate-Term Investment Grade Bond Mutual Funds
For the slightly more risk tolerant, intermediate-term investment grade bond mutual funds offer a slightly better rate of return than an investment in GNMA funds. Standard and Poor’s, Moodys, and other rating agencies classify by risk level individual bonds issued by the U.S. Government, government agencies, and corporations. The lowest risk bonds are categorized as AAA. Other high rated bonds receive AA or A ratings. All three are categorized as investment grade bonds. A portfolio of these bonds with an average maturity of approximately five years would be categorized as an intermediate-term investment grade mutual fund. You can go to the Web site of Vanguard or any other leading mutual fund to determine the current yield and the volatility of any fund. You should also look at the prior year’s overall return and volatility. These bond funds pay interest monthly.
3. Intermediate-Term Treasury Mutual Funds
Another option for you to consider is an intermediate-term Treasury mutual fund. The U.S. Treasury issues three types of bond instruments. All are rated AAA. Treasury Bills have maturities of one year or less. They are the safest in terms of capital preservation, but they also pay the smallest amount of interest. When the Federal Reserve maintains an easy money policy, as they do now, the rate of interest paid on Treasury bills is less than the inflation rate. The Treasury also issues Treasury bonds, which have a maturity greater than 10 years and up to 30 years. The interest rate for these bonds will always be greater than that of Treasury Bills, but there is a great deal more risk for the investor. When you purchase a bond with a long maturity, such as a Treasury bond the value of the bond will fluctuate a great deal based on the direction of interest rates. If interest rates increase, and they eventually will, the value of Treasury bonds will fall dramatically because of the long maturity. For this reason, I do not recommend investments in Treasury bonds or Treasury bond mutual funds.
The third type of maturity is Treasury notes. Their maturity is more than one year, up to 10 years. Mutual funds which hold these securities are called intermediate-term Treasury mutual funds. These are stable funds which have had good long-term performance. Interest is paid monthly. The return for this investment may be lower than that for GNMA funds if the Federal Reserve continues to follow an easy money policy. Again, you can go to various fund Web sites to determine current yields.
4. TIPS Mutual Funds
Another portfolio option to consider is Treasury Inflation-Protected Bonds (TIPS). These funds are a pool of high quality bonds securities issued primarily by the U.S. Treasury and governmental agencies that are indexed to inflation. With this investment, you receive a nominal amount of interest, but you also receive an additional payment based on the rate of inflation. In periods of high inflation, this is an excellent investment. You receive payments of interest, and the inflation adjustments quarterly. You should purchase these funds in a tax-deferred account. Otherwise, any increase in value because of inflation is immediately taxable as a capital gain.
5. Intermediate-Term Municipal Bond Funds
Municipal bonds are issued by state and local governments. Most have very good ratings. For individuals in high tax brackets (greater than 28 percent) municipal bonds offer a tax advantage because the income received is not taxed at the Federal level. Short-term municipal bond funds generally do not earn a great deal of interest, while long-term municipal bond funds have a significant amount of risk. Intermediate-term municipal bonds, on the other hand, have been stable, offer reasonable interest, and should be considered by individuals in higher tax brackets.
The Following are the yield to maturity for various mutual funds with the Vanguard’s risk ratings. The ratings go from 1 to 5 with 1 as the lowest risk and lowest rate of return. All of the investments mentioned in my article have a risk rating of 2, meaning some risk, but better income. The Securities and Exchange Commission yields are quoted for Vanguard funds, but they would be similar for all the major fund families.
|Type of Fund||Yield||Risk Rating
(As of 2-26-09)
|Prime Money Market||1.17 percent||1|
|Short-Term Treasury Fund
(Average maturity 1-3 yrs)
|GNMA Fund||4.75 percent||2|
|Intermediate Investment-Rated Bond
(Average maturity 5-10 years)
|Intermediate-Term Treasury Mutual Funds
(Average maturity 5-10 years)
|Intermediate-Term Municipal Bond Funds
(After tax 6-12 year maturity)