At age "75-plus," Jean Schnall is giving herself a crash course in investing. With low interest rates shrinking her investment income, "it's a real struggle," says Schnall, an artist living in Scarsdale, N. Y. "I rely on interest income." To offset the loss, she's cutting back on "everything except food" and moving some of the money from certificates of deposit to global and domestic bond funds. "I know there is a risk to your principal, but where else can you go?" says Schnall. "I can't live on what I'd get if I invested all of my money in CDs."
With interest rates on CDs and money-market funds spiraling downward, Schnall is not the only one singing the interest-rate blues. Short-term interest rates have dropped more than two points from a year ago. For those who want to refinance a mortgage, finance a car, or borrow for business, the drop is welcome. But for people who depend on investment income, falling rates are a serious downer. "This is going to hit older people right in the teeth," says Judith A. Shine, a Denver-based financial planner.
To fight back, people are pouring money into riskier alternatives, from short-term bond funds to Ginnie Mae funds and even into the stock market, where they would never have thought to venture a few months ago.
Ginnie Mae funds, which hold mortgages backed by the Government National Mortgage Assn., are a strong beneficiary of the search for higher yields. And indeed, the current yields are almost three percentage points above six-month CD rates. But the dangers in Ginnie Maes are twofold. The first danger is inherent to any fixed-income investment: If interest rates rise, the principal value of your investment falls. Ginnie Maes, however, add their own unique "prepayment" risk. If interest rates fall, mortgages may be refinanced early, which lowers the yield on the fund.
This isn't the first time that low rates have sent investors running to Ginnie Maes. When interest rates slumped in the mid-1980s, assets poured into the funds. In 1986 and 1987, when mortgage rates were about 9%, close to today's levels, many holders of mortgages at 11.5% to 14% refinanced. "I think the same thing will happen now to a lesser extent," says Don Phillips, publisher of Chicago-based Morningstar Mutual Funds. The drop in yield caused investors to flee the funds, and many incurred losses. The prepayment risk today is less than it was in 1986 and 1987, since the segment of the market where it makes sense to refinance mortgages is much narrower, says Michael Waldman, a managing director at Salomon Brothers Inc.
GRAY MATTER. One Ginnie Mae fund seeing a lot of action is the American Association of Retired Persons' (AARP) no-load Ginnie Mae & U. S. Treasury Fund, managed by Scudder, Stevens & Clark Inc. and yielding about 8%. Since Jan. 1, the fund has grown by $600 million, to $3.2 billion. In the same period last year, $46 million flowed in. "We're not looking for the highest-coupon mortgage pools, because if you reach too high and mortgage rates go down, a lot of mortgages will be refinanced and yields will suffer," says Cuyler W. Findlay, chairman of the AARP Investment Program. The fund increases stability by keeping 30% of its capital in short-term (five years or less) U. S. Treasuries.
Unlike the AARP fund, not all Ginnie Mae funds require you to be 50 or over, and they're seeing gobs of money flow into their coffers. Vanguard Group's Ginnie Mae fund, which has an 8.5% yield and an average maturity of 10 years, swelled tenfold this year, to more than $4.2 billion. "It seems to be coming from CDs and the cookie jar and maybe the mattress," says Brian S. Mattes, spokesman for Vanguard Group. An alternative to the Ginnie Mae fund is Vanguard's Bond Market Fund, he says, which invests in both government and corporate bonds and has an 8% yield.
MULTIMARKET MOVES. Vanguard is not the only one pushing bond funds. The 29,000 subscribers to Donoghue's MoneyLetter saw a telling shift in the newsletter's model portfolio this month. A chunk of assets was moved out of domestic stock funds and money funds and into no-load short-term bond funds, which invest in bonds with about three years to maturity. "We chose the easiest and closest alternatives to money funds that we could find," says Walter S. Frank, MoneyLetter's chief investment officer. In the conservative portfolio, subscribers are advised to move 15% into domestic short-term funds, and Scudder's Short-Term Bond Fund, which yields around 8.7%, is listed as the "top buy." Also recommended is a move of 15% into Blanchard's Short-Term Global Income Fund, which yields about 10.4%.
What are stockbrokers pitching to rate-chasers? Funds being promoted include short-term multi-market funds, which invest in foreign government bonds and CDs, and adjustable-rate mortgage (ARM) funds, says Phillips. He is leery of such funds: "The ARM market is relatively new and untested, and multimarket funds have currency risk." The funds have loads, or sales charges, of about 3%. Brokers are also suggesting collateralized mortgage obligations (CMOs), highly complex investments that have yields around 9%, but can also offer large risks to principal.
Even banks are pushing bond funds. Citibank will soon introduce an intermediate government bond fund at an "attractive yield," says Loren E. Smith, managing director of New York marketing. He says Citi is spending a lot of time "making sure that people know what they're buying" and that consumers think in terms of total return from a bond fund--price appreciation plus yield--instead of just focusing on rate.
Some savers are sticking with CDs, regardless of the rates. Arthur and Ida Hoag, of Bradenton, Fla., are feeling a $400-a-month pinch because of lower rates on their CDs, but want the security of a CD. To offset their lower interest income, the Hoags will take a bus tour of New England instead of visiting Europe. They've also saved $360 by skipping season tickets to nearby amusement parks in favor of $2 ballroom-dancing tickets on weekends. At Saybrook Bank & Trust in Old Saybrook, Conn., "people are positioning themselves to react to a rise in rates" by moving into three-month CDs, says William H. Swift, a senior vice-president with the bank.
To get beefier rates, investors are having to lock up money for longer periods. Ralph and Sorel Bergman of Chicago saw the biggest drop in their income from declining CD" says Sorel Bergman. "When their CDs come due, they put on their walking shoes. They really shop, because you don't see CDs advertised that much anymore."
It's true that bank promotions for CDs have largely dried up. But some banks are seizing the opportunity and aiming rate promotions at older investors, who have the largest CD holdings. One bank that aggressively pursued CD money was Atlanta's $5 billion Bank South Corp. On July 1, Bank South began offering an 18-month CD with a variable rate based on the saver's age. The base rate in July was 7%, offering a 65-year-old a 7.65% rate. By August, the base rate was down to 6.35%. Still, the six-week promotion was the most successful in the bank's history, drawing in $135 million, $92 million of which was new money attracted from other financial institutions, says a bank spokesman.
The small investor is also braving the stock market. "We're seeing strong cash flow into our equity-income fund, which invests mainly in stocks with above-average dividend yields," says Steven Norwitz, a spokesman at T. Rowe Price Associates Inc. Says financial planner Shine: "What low interest ratesare going to do to people--and they're going to hate it--is to force them to understand the equity market" and learn about growth and volatility.
Small investors can't look forward to any sudden reprieve from interest rate sticker-shock. As Charles I. Clough, chief investment strategist at Merrill Lynch & Co., sees it, they're discovering a very different sort of investment hazard today. "It's very risky to stay at the short end of maturities," says Clough. "There's just not enough economic activity in industries that borrow a lot to ensure that there would be high rates at any time." With that in mind, savers would do well to start studying the markets. "People have to learn to deal with a new way of investing," says Shine. "They can't just go for yield anymore."