With I-Bonds, Less Is More
What's the catch on I-bonds? They're yielding 4.66% while other Treasuries are yielding half that.
By Kimberly Lankford, Contributing Editor
From Kiplinger's Personal Finance magazine, October 2003
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What's the catch on I-bonds? They're yielding 4.66% while other Treasuries are yielding half that. Am I missing something? --Jo Ann Torrence, Meherrin, Va.
There's no catch. That 4.66% rate for inflation-indexed savings bonds was set May 1 and consists of two parts: a fixed component -- currently 1.1% -- which applies for the 30-year life of the bond; and a variable component, currently 3.5% annually, that reflects the change in the consumer price index during the six months prior to May 1. The inflation part of the rate adjusts every six months, so the 3.5% -- which was pushed up by a spike in energy prices just before the U.S. invaded Iraq -- only applies until November 1.
No one can say exactly what will happen after that, but the fixed component is likely to be higher -- probably around 1.5% -- and the inflation component is likely to be lower, with inflation having dropped back to a 2% annual rate. If the combined rate is 3.5%, buyers who purchase bonds in November will actually get a better deal than those who bought before the change.
How can 3.5% be better than 4.66%? Because those who bought bonds at the 4.66% rate will be earning just 3.1% come November (assuming a 2% inflation factor). Remember, the fixed component is the more important factor, since it holds for the life of the bond. No matter when you buy, the inflation factor is adjusted every six months.
A risky investment option
I'm thinking about buying options on a stock before the company's earnings are released as a way to make a quick dollar. Can you enlighten me on the ups and downs of this move? --John Martinich, Austin, Tex.
Have you thought about a trip to Las Vegas instead? You can eat cheaply, take in some shows and probably have more fun at the slots ... without taking much more risk.
Options represent the right to buy or sell a particular stock (or index or commodity) at a preset price -- known as the strike price -- on or before a deadline, called the expiration date. An option to buy something is a "call" option. One to sell is a "put."
Some option strategies are designed to bring in fast cash, others are conservative plays designed to generate income and reduce portfolio volatility. However, speculating in puts or calls immediately before a company reports earnings is a "crapshoot," says Lawrence McMillan, an options trader in Randolph, N.J. For this plan to work, he says, you must guess correctly what the earnings news will be and how investors will react to it. Even if you're right about the general direction, there are complicating factors, such as the price you pay for the option and its expiration date. A call option can lose far more of its value than the stock if the news is bad. If it expires when the stock price is below the strike price, you lose 100% of your stake.
If you guess correctly and the company delivers unexpectedly good news (great for call holders) or unexpectedly bad news (great for put holders), you can make a quick killing. But your plan is speculation of the highest order, which is why we think a trip to Vegas is a better bet.
Independent stock advice
I'm looking for independent stock research. Some letters tout their wild successes, but I'm skeptical. Do you have a list of reputable firms and their records against Standard & Poor's 500-stock index? --Eugene Pebworth, Land O Lakes, Fla.
Start by looking for letters that focus on the kinds of stocks that interest you. If you buy only blue chips, for example, you probably won't be interested in a letter that specializes in small-company stocks.
If you want wide-ranging coverage and loads of data, The Value Line Investment Survey ($598 per year) and Standard & Poor's The Outlook ($298 per year) are worth sampling. According to the Hulbert Financial Digest, which tracks investment letters, Value Line's top-rated stocks for timeliness have beaten the market over the past 23 years (the extent of Hulbert's database). The Outlook's performance hasn't been as good but has been respectable. Zacks Advisor, from Zacks Investment Research ($239 per year), is another broad-based service with a good long-term record.
If you're interested in a letter that scouts for undervalued and overlooked stocks, try The Prudent Speculator ($295 per year, www.prudentspeculator.com). Its picks have returned an annualized 17% over the past 23 years, beating the returns of Value Line and every other stock-picking letter that Hulbert lists.
Extra 401(k) deposits
I am over 50 and contribute 10% of my income -- the company limit -- to my 401(k). Can I also make after-tax contributions? --G.J., Houston, Tex.
It's up to your employer whether to allow after-tax contributions. But even if your plan does allow them, think twice before you add after-tax money to your 401(k) retirement plan.
A Roth IRA would be a better choice for the first $3,500 of extra money you can stash away. Earnings on contributions grow tax-deferred in both 401(k)s and Roth accounts. But Roth withdrawals are completely tax-free in retirement, whereas all earnings on the after-tax 401(k) contributions will be taxed in your top tax bracket when you withdraw the money. Also, mixing pre- and post-tax money in a 401(k) can create tax headaches when you begin withdrawals.
My thanks to Jeff Kosnett and Melynda Dovel Wilcox for their help this month.