Fixed Income -- Juice Your Returns

June 05, 2007

A dyed in the wool indexer says that he can beat the market ... in fixed income.

Does earning 6 – 7% on your cash with the backing of the U.S. Government sound too good to be true? It isn’t!

Though the little guy is at a huge disadvantage when it comes to beating the stock market, the tables are turned when it comes to fixed income. The small investor can get thousands more every year than is available to large institutions, and this column is going to show you how.

Let me start by stating that any large institution that goes shopping for funds that are backed by the U.S. Government must turn to Treasury bonds. As of the time of this writing, both five and ten-year treasury bonds were yielding about 4.5% annually. Sure, Treasuries are state tax deductible but that only raises the effective yield to about 4.65%.

Truth be told, a few years back, I had the vast majority of my fixed-income in Vanguard bond funds. But now I’ve discovered a better way and am investing in relatively short-term instruments paying as high as 6.98%, and backed by agencies of the U.S. government.

I’ve often noted that things that appear too good to be true usually are, but this time it’s legit. We’re talking good old-fashioned Certificates of Deposits (CDs) at banks and credit unions. While the products aren’t new, finding the ones with the highest rates is critical.

For starters, make sure that any CD you buy is backed by an agency of the U.S. Government. Any institution you are considering should be insured by either the FDIC or the NCUA. Check out the amount of the insurance with each institution. The accompanying chart gives some general guidelines.

As of the time of this writing, Justice Federal Credit Union of Washington DC had a 6.25% APY 2-year CD and a 6.35% APY for amounts of $100K or more. In order to qualify for membership, however, you may need to join the National Sheriffs Organization at a one time cost of $35, which would lower your APY by 0.02% for a $100K amount.

Alliance Bank in Culver City, California, has a deal I’m pretty excited about. It’s a 3 year IRA CD that pays a variable rate of prime minus 1.5%. With compounding, that equates to an incredible 6.98% APY! Booyah! Sure the rate could go down, but this CD only has a 3 month surrender charge.

So while billion dollar institutions are earning rates on treasuries far below 5%, I’m earning rates approaching 7% APY. Why? Because insurance limits between $100K and $250K mean a lot to small investors like us, but are virtually meaningless to the investor with billions of dollars to invest.

Finding the right institutions does involve a little work. Bankrate.com is a web site that posts what it calls the highest rates, though institutions must pay to have their rate posted. As of the time of this writing, Bankrate.com showed the nation’s highest 2-year and 3-year CD’s to yield only 5.48% APY. Brokerage houses also sell CD’s but the key word here is “sell.” The banks are paying commissions to the brokerage houses so they have to pay you lower rates. Don’t expect an investment advisor to give you the highest rates when there is zippo in it for him.

I’ve found the highest rates from a few different sources, one of which being the local newspaper. About half of the highest rates have come from there through such credit unions as ENT, Colorado Springs Credit Union, Colorado Springs Employees Credit Union, and Pentagon Federal.

Next is an internet site called www.bankdeals.blogspot.com. Here people post rates and give links to the institutions.

Finally, an old fashioned Google search of “highest CD rates” often comes up with some great rates as well.

Now, after you’ve found a great rate, a little due diligence is in order. First and foremost is to make sure they are insured by either the NCUA or FDIC by going directly to the agencies’ own web sites. Next, call the institution and make sure they will hold that rate while you are sending the funds. These rate specials come and go with lightning speed. Finally, understand that most of these CD’s will automatically renew upon maturity, so it is critical that you write down the maturity dates and start looking for the best rates again when that date is getting near.

If you’re wondering if the work you have to put in is worth it, consider that a $100K five year CD earning an extra 1.50% can easily pay an extra $9,300. I’d say that’s a pretty decent ROI for a couple hours of time.

Remember, when it comes to investing, play a game you can win. Trying to beat the stock market will only land you at the loser’s table. Instead, go for the slam dunk cash returns of beating the institutions on fixed income. It takes a little time, but sure pays off better than clipping coupons or fighting for that $25 rebate.


A Guideline to NCUA and FDIC Insurance limits.

  • Taxable accounts are insured to $100K per institution for an individual account and $200K for joint account.
  • IRAs are insured for $250K in addition to the insurance on a taxable account.
  • If you are letting your interest compound, make sure you keep your limits below these amounts.
  • There are ways to increase the total insured funds at each institution but always confirm that all of your funds are insured.
  • Go to www.NCUA.gov or www.FDIC.gov to learn more.

A Guideline to proper CD Due Diligence.

  • Always make sure your funds are insured by going directly to either www.NCUA.gov or www.FDIC.gov. Never get greedy by chasing a higher yield from an uninsured institution.
  • Speak to someone at the institution and confirm that they will hold this rate until you are able to get your funds to them.
  • Check out the early withdrawal penalty. Penalties of 6 months or shorter are generally acceptable.
  • Make sure you are dealing directly with the institutions. Many sites fail to mention they charge a hefty fee which, of course, reduces your return.
  • Try not to choose the option of letting the CD automatically renew. You want to be reminded that it’s coming due so you can again shop for the highest rates. Sometimes, you will have no choice.
  • Always mark the maturity date on your calendar and, a few weeks earlier, be ready to shop for new rates yielding above treasuries.

Allan Roth is a CPA and CERTIFIED FINANCIAL PLANNER. Allan is the founder of Wealth Logic, LLC, an hourly based financial planning and licensed investment advisory firm. He is an adjunct finance faculty member at the University of Colorado at Colorado Springs. He can be reached at 719-955-1001 or at [email protected]

This piece is reprinted from the Colorado Springs Business Journal.

 

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