I’m looking to place a significant amount of cash in one or two year low-risk, cash investments such as bonds or CDs and have started researching the subject, but am a little confused and hope someone here knows something about the subject.
First our situation: my wife’s been doing a great job increasing our stash through buying and selling of Taiwan stocks, but her game has been very high risk, betting the whole pile on one or two companies (successfully). It’s been a good ride, but now it’s time to start seriously decreasing our risk. I realize everyone saving for retirement should have a diversified portfolio, with a significant portion (10%, 20%, etc. depending on age and risk aversion) in safe, fixed income investments such as bonds and that’s part of my motivation. Additionally, we intend to move to the States and buy a house in a couple of years, so we want to be certain we’ll have lots of cash then and won’t have to wait for a lousy market or investment to rebound.
Here’s what I’ve learned.
Bonds are instruments sold to raise money for a government or corporation. The safest bonds are issued by the US government. Treasury bills mature in one year or less. Treasury notes mature in 2, 3, 5 or 10 years. Treasury bonds have maturities of more than 10 years. One can buy treasuries (a) direct from the government at savingsbonds.gov/ or (b) individually through your broker or © in a bond fund. Instead of straight treasuries, one can buy bonds from federal government agencies, such as Fannie Mae or Ginnie Mae, which are also safe because they�re backed by the US government
Or one can buy state or municipal bonds, which are less safe (eg. Holders of Orange County, CA, municipal bonds lost out when the county went bankrupt) but the yield should be higher as compensation. Additionally, muni bonds are tax-free, which adds value to them if one is in a high tax bracket (but makes no difference if one lives in Taiwan and pays no US taxes). Finally, there are corporate bonds, which should have an even higher yield but correspondingly higher risk.
It’s hard to say whether its wiser to buy individual bonds or bond funds. The average bond fund charges about 1% annually in expenses (although Vanguard, not surprisingly, charges low expenses). But bond funds, like stock funds, are less volatile than individual bonds. Moreover, one is likely to incur a commission if one sells individual bonds before maturity (that’s why small investors in bonds should hold them to maturity.
Par value is the amount of money the investor receives when the bond matures, which is usually $1,000. Coupon rate is the interest one receives, which may be paid monthly, quarterly, annually, etc, according to the bond. Maturity date is when the bondholder is entitled to receive the full face amount of the bonds. Ordinarily one pays less than par value to purchase the bond, receives periodic interest payments, but can only redeem the bond for its par value at the maturity date. One can also sell the bond before the maturity date, but if people expect interest rates will rise you’ll get less than par value for the bonds; conversely, if people expect interest rates to fall (unlikely for the foreseeable future) you’ll get more than par value.
Not surprisingly, long-term treasuries usually pay a higher yield, or interest rate, than short-term treasuries. Oddly enough, though, that’s not always the case. One article I read, dated March 14, 2006, reported that the interest rate on 6-month treasuries (4.74%) was then higher than that on 30-year treasury bonds (4.66%). That’s called an inverted yield curve and is very strange. Apparently the reason for that is that the Fed Reserve sets short-term interest rates, but long-term rates are set by the market, and the two don’t always act the same way. The significance of an inverted yield curve is that cash is king and one should not put new money in bonds, as rates are expected to keep rising and value of existing bonds will therefore drop.
The above inverted yield curve doesn’t seem to be present any longer, but today’s NYT reported that Bonds Prices Fall on Robust Economic Data. According to that article treasuries are now paying the following rates:
30 yr bond: 5.24%
10 yr note: 5.15%
2 yr note: 4.94%
3 month bill: 4.82%
You can also see nice charts of treasury yields at this site:
flagship5.vanguard.com/VGApp/hnw … ketSummary
In light of falling bond yields, apparently CDs are a better place to invest cash today. Previously I just went down to Taipei (Fubon) Bank and bought a CD. But the rate wasn’t so great (4.5% on a 1 yr CD), so I want something better. I checked out the following page at Vanguard . . .
flagship2.vanguard.com/VGApp/hnw … skFrameset
. . . and see one can buy CDs from dead people and, for example, one can buy a CD with a maturity date of 5/7/07 (basically a 1 yr CD) that pays a 5% yield. Great. But how the hell does one make such a purchase? I assume one places an order with Vanguard at that page, but it appears to me the volume of such CDs is relatively miniscule compared to the volume of traffic at Vanguard�s site, so the good CDs would sell out immediately. What then? Do they buy something else roughly comparable for you?
Anyone have anything to add? For a 1 or 2 year fixed investment, CDs are probably as good as anything now, right? How do I buy a CD with the best rate?