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Here are some of the safest places to invest your money. But the price of safety may be low returns
Warren Buffett's mentor, legendary investor Benjamin Graham, wrote that when challenged "to distill the secret of sound investment into three words, we venture the motto, Margin of Safety." Those are wise words for all seasons, but especially at a time like this. Even after the Wall Street crisis dies down, households will remain under pressure to create their own margins of safety by saving more and borrowing less.
Places to stash cash and hedge against risks like inflation and a weak dollar range from plain-vanilla Treasuries to certificates of deposit denominated in euros. All of the options below rely on the backing of the U.S. government rather than private-sector promises.
SHORT-TERM TREASURY SECURITIES
The allure of safety was so strong late in the week of Sept. 15 that the yield on the three-month T-bill went negative at one point. That's right, below 0%. The yield is up, but investors are being paid less than 1% on their investment. That said, anyone tempted to go for a higher yield by buying the 10-year Treasury bond at 3.79%, or the 30-year at 4.37%, should think twice, with consumer inflation up 5.1% so far this year. "Treasury yields are stupidly low," says Robert Auwaerter, head of the fixed-income group at Vanguard Group.
TREASURY INFLATION-PROTECTED SECURITIES
The fear over rising prices is why more investors are flocking to U.S. Treasury Inflation-Protected Securities (TIPS). "The yield on long-term inflation-indexed bonds is around 2%," says Laurence Kotlikoff, head of the financial planning firm ESPlanner. "That's surely the place for those who must seek shelter from this storm." The bonds are available in 5-, 10-, and 20-year maturities.
TIPS offer a fixed interest rate above inflation, as measured by the consumer price index. The bond's principal adjusts semiannually as the CPI changes. TIPS tend not to move in sync with other fixed-income securities, so they're a good diversifier. An additional advantage is that they protect against deflation, or a decline in the overall price level of goods and services. After all, Japan became known as Deflation Nation when its finance mania crashed in the late 1980s. Deflation also gripped the world economy during the Great Depression. TIPS offer a "deflation floor" that protects principal value if the fear of falling asset values turns into a deflationary episode. It guarantees the TIPS owner either the inflation-adjusted principal or the par value at maturity—whichever is greater.
TIPS have one drawback: taxes. In essence, Uncle Sam requires owners in taxable accounts to pay income taxes on inflation-adjusted gains before getting any of the inflation-adjusted money at maturity. The trick to avoiding the tax hit is to own the bonds in a tax-deferred retirement savings account. Most major fund companies and financial firms offer a TIPS fund, such as the PIMCO Real Return Bond Fund and the iShares Lehman TIPS Bond (TIP).
Taxes aren't an issue with I Savings Bonds, the federal government's other inflation-protected security. These 30-year bonds allow money to compound tax-deferred until they are cashed in. There are no commission costs. I bonds redeemed before five years forfeit the three most recent months' interest, but after that there is no penalty at redemption.
At first glance, the rate on I bonds seems to be a joke. The fixed rate on I bonds bought before November of this year is 0% (the rate is announced every May and November). Any gain will come from adjustments in the CPI. Earlier this year the Treasury Dept. cut deeply into how much you can put away in I bonds. Savers can now buy $10,000 worth—$5,000 at treasurydirect.gov and $5,000 in paper bonds at a bank.
MONEY MARKET MUTUAL FUNDS
Early in the week of Sept. 15, investors started a money fund version of a run on the bank. Nearly $200 billion cascaded out of money funds before stopping on Sept. 18 when the Treasury Dept. put the full faith and credit of the U.S. taxpayer behind the implicit "don't-break-the-buck" pledge at money funds. The principal value of money-market funds—including tax-exempt ones—is now guaranteed.
BANK SAVINGS ACCOUNTS
Investors can earn a good yield and enjoy FDIC safety at online banks. At ING Direct (ING), for instance, a savings account pays 3% and a 12-month CD, 4%. No one with an account of $100,000 or less has lost a penny from a bank failure since the government's insurance fund was created in 1933. (Federal credit unions have their own backstop, the National Credit Union Shares Insurance Fund.) The $100,000 limit is something of a misnomer. It's relatively easy to park a multiple of that sum at the same bank and get it insured. For instance, a husband and wife can each have an account with $100,000 and an IRA holding a certificate of deposit worth $250,000, plus a joint account with $100,000 per spouse. That covers $900,000.
The family could up the insured amount through revocable trust accounts, such as a payable-on-death (POD) trust that allows $100,000 per beneficiary. If the couple has three kids, the husband can have a $100,000 POD account with his wife as beneficiary; she can do the same with him. The couple can also have a $600,000 POD account with their kids as equal beneficiaries. According to the FDIC, an additional $800,000 is covered, for $1.7 million at one bank. One can open up accounts at different banks, but it may be easier to track multiple CDs by buying so-called brokered CDs. A broker will take, say, $1 million and buy 10 $100,000 CDs, each at a different bank. This keeps paperwork in one place.
Most of us are focused on safety now, but there's also concern about the falling value of the dollar. Anyone worried about a weak dollar in the wake of the government's bailout might consider a currency-denominated CD. EverBank in Jacksonville, Fla., offers a euro CD that's FDIC-insured. The minimum is $10,000. As of Sept.24, a three-month euro CD yields 2.38% and a one-year euro CD, 2.75%.