Personal Financial Planning: An "How-To" Guide (part 22)

A Variety of Ways To Save

by

Charles Lamson

During the past couple decades or so there has been a tremendous proliferation of savings and short-term investment vehicles, particularly for the individual of modest means.

smart.sites If you are not satisfied with the CD rate at your local bank, go to Bankrate.com (www.bankrate.com). You will find not only the highest rates on CDs and savings accounts nationwide but also the checking account and ATM fees at banks in your city.

Today, investors can choose from savings accounts, money market deposit accounts, money market mutual funds, NOW accounts, certificates of deposit, U.S. Treasury bills, Series EE bonds, and asset management accounts. Let's look at three types of deposits and securities.

Certificates of Deposit

Certificates of deposit (CDs) Differ from other savings instruments in that CD funds (except for CDs purchased through brokerage firms) must remain on deposit for a specified period, which can range from 7 days to as long as 7 or more years. Although it is possible to withdraw funds prior to maturity, an interest penalty usually makes withdrawal somewhat costly. Although the bank or other depository institution is free to charge whatever penalty it likes, most require forfeiture of some interest. Since October of 1983, banks S&Ls, and other depository institutions have been free to offer any rate and maturity CD they wish. As a result, a wide variety of CDs are offered by most banks, depository institutions, and other financial institutions such as brokerage firms. Most pay higher rates for larger deposits and longer periods of time. CDs are convenient to buy and hold because they offer attractive and highly competitive yields plus federal deposit insurance protection.

U.S. Treasury Bills

The U.S. Treasury bill (T-bill) is considered the ultimate safe haven for savings and investments. T-bills are issued by the U.S. Treasury as part of its ongoing process of funding the national debt. They are sold on a discount basis in minimum denominations of $1,000 and are issued with three month (13-week) or 6-month (26-week) maturities. The bills  are auctioned off every Monday. Backed by the full faith and credit of the U.S. government, T-bills pay an attractive and safe return that is free from state and local income taxes.

T-bills are almost as liquid as cash because they can be sold at any time (in a very active secondary market) without any interest penalty. However, should you have to sell before maturity, you may lose some money on your investment if interest rates have risen, and you will have to pay a broker's fee as well. Treasury bills pay interest on a discount basis and thus are different from other savings or short-term investment vehicles---that is, their interest is equal to the difference between the purchase price paid and their earned value at maturity. For example, if you paid $980 for a bill that will be worth $1,000 at maturity, you will earn $20 in interest ($1,000 - $980).

An individual investor may purchase T-bills directly by participating in the weekly Treasury auctions or indirectly through a commercial bank or a security dealer who buys bills for investors on a commission basis. In addition, T-bills may now be purchased over the Internet or by using a touch-tone phone (call 800-722-2678 and follow the interactive menu to complete transactions).

smart.sites At the T-bill page of the Bureau of the Public Debt Online, www.publicdebt.treas.gov/sec/sec.htm, you can learn about T-bills and then buy them online.

Outstanding Treasury bills can also be purchased in the secondary market through banks or dollars. This approach gives the investor a much wider selection of maturities from which to choose, ranging from less than a week to as long as 6 months.

Series EE Bonds

Although issued by the U.S. Treasury on a discount basis, and free of state and local income taxes, Series EE bonds are quite different from T-bills. Savings bonds are accrual-type securities, which means that interest is paid when they are cashed in or before maturity, rather than periodically during their lives. The government does make a 10-year maturity and are available in denominations of $500 to $10,000. Unlike EE bonds, HH bonds are issued at their full face value and pay interest semiannually at the current fixed rate.

Series EE bonds are backed by the full faith and credit of the U.S. government and can be replaced without charge in case of loss, theft, or destruction. You can purchase them at banks or other depository institutions, or through payroll deduction plans. Issued in denominations from $50 through $10,000, their purchase price is a uniform 50 percent of the face amount (thus a $100 bond will cost $50 and be worth $100 at maturity).

The actual maturity date on EE bonds is unspecified because the issues pay a variable rate of interest. The higher the rate of interest being paid, the shorter the time it takes for the bond to accrue from its discounted purchase price to its maturity value. Bonds can be redeemed any time after the first six months (in May and November) and change with prevailing Treasury security market yields. To obtain current rates on Series EE bonds, call your bank, call 800-487-2663, or use the Web link below for the savings bond site.

Smart.sites Everything you always wanted to know about U.S. Savings Bonds---how to buy them, current rates, and a pricing calculator for bonds you own---is at www.savingsbonds.gov.

In addition to being exempt from state and local taxes. Series EE bonds provide their holders with an appealing tax twist: Savers need not report interest earned on their federal tax returns until the bonds are redeemed. Although interest can be reported annually (for example, when the bonds are held in the name of a child who has limited interest income), most investors choose to defer it. A second attractive tax feature allows partial or complete tax avoidance of EE bond earnings when proceeds are used to pay education expenses, such as college tuition, for the bond purchaser, a spouse, or an other IRS defined dependent. 

*SOURCE: PERSONAL FINANCIAL PLANNING, 10TH ED., 2005, LAWRENCE J. GITMAN, MICHAEL D. JOEHNK, PGS. 153-155*

end

smart.sites

At the T-bill page of the Bureau of the Public Debt
Online, www.publicdebt.treas.gov/sec/sec.htm, you
can learn about T-bills and then buy them online.

Smart.sites

Everything you always wanted to know about U.S. Savings
Bonds---how to buy them, current rates, and a pricing
calculator for bonds you own---is at
www.savingsbonds.gov.

smart.sites

If you are not satisfied with the CD rate at your local
bank, go to Bankrate.com (www.bankrate.com). You
will find not only the highest rates on CDs and
savings accounts nationwide but also the checking
account and ATM fees at banks in your city.

smart.sites

At the T-bill page of the Bureau of the Public Debt
Online, www.publicdebt.treas.gov/sec/sec.htm, you
can learn about T-bills and then buy them online.

Smart.sites

Everything you always wanted to know about U.S. Savings
Bonds---how to buy them, current rates, and a pricing
calculator for bonds you own---is at
www.savingsbonds.gov.