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The Risk Behind CD Alternatives

By Jeff Brown
With CD, savings and checking yields in the basement, is there an alternative?  Perhaps an interest-paying investment that’s a bit more generous?

Sure. But don’t forget the old saying: If it looks too good to be true, it probably is.

Savings accounts yield an infinitesimal 0.26 percent, according to the survey, while interest-bearing checking accounts are even stingier, paying just 0.16 percent.

The obvious alternative is a certificate of deposit, but you’ll never get rich on those, either. The six-month CD pays just 1.12 percent. Tie your money up for five years and you’ll make a princely 2.3 percent – probably not enough to keep up with inflation.

If you fixate on yield to the exclusion of all else, you can do much better. Morningstar (Stock Quote: MORN), the market-data company, lists a variety of bond funds with enticing yields.

In the corporate bond category, the Fidelity Strategic Income Fund (Fund Quote: FSICX), yields a pleasing 6.24 percent with a mix of government and corporate bond holdings.

And then there’s the 9.94 percent yield from PIMCO High Yield D fund (Fund Quote: PHYDX), which invests in high-yield corporate bonds, also known as junk bonds.

But before you grab the phone to invest, look at the rest of the picture. The Fidelity fund lost 11.4 percent in 2008, while the PIMCO fund tumbled 24 percent.

Many investors new to bond funds, such as those more accustomed to CDs and other bank savings, find bond losses puzzling, thinking bonds are considered “safe.”

The problem is that a bond’s value can go down, more than wiping out all those nice interest earnings. After a bond is issued and begins trading in the secondary market, its price is determined by supply and demand, and many factors can influence the result.

One of the most important is changes in interest rates. If you buy a bond today that yields 4 percent, and want to sell it in six months, no one will pay full price, especially if newer bonds yield 5 or 6 percent, so the bond’s price falls.

Before you buy a bond fund, take a look at its “duration” figure, which shows how sensitive the fund is to changes in interest rates. A one-year duration means that if prevailing interest rates rise by 1 percentage point, the bond will lose 1 percent of its value.

The PIMCO High Yield D fund has a duration of nearly five years. A 1 percent rise in rates would cause the fund’s share price to fall by 5 percent. Of course, it works the other way, too, with the fund shares rising 5 percent if rates fall by 1.

Bottom line -- investing in bond funds with especially high yields is just like playing the stock market, it’s a risky game. It’s not for safety-seeking investors like those who cherish CDs, which are government-insured against loss.

CDs, savings and checking accounts are all about safety and convenience. If you want safety, stay within these categories when you search for better yields. Use the shopping tool, and consider a laddering strategy, devised with the CD Ladder Calculator, to get the best yield you can while preserving reasonable access to your money.

Also be sure to check out the Certificate of Deposit Calculator to figure out potential CD earnings.

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