Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: THURSDAY, December 29, 1994 TAG: 9412300079
SECTION: EDITORIAL PAGE: A9 EDITION: METRO
SOURCE: RAY L. GARLAND
DATELINE: LENGTH: Long
Almost a third of the nation's population was born between 1944 and 1964, thus qualifying for the done-to-death moniker of "baby boomer." On the surface they seem to be doing pretty well: the malls are full, the suburbs keep expanding, most are working and having fewer children requiring expensive upkeep.
But one thing they aren't doing is saving money. "Boomers aren't very concerned about the long run," said Karen Meredith, executive director of the American Association of Boomers. "I think the outcome will be extremely bad unless they become thrifty now."
Half of all boomers have no pension in prospect other than Social Security, and two-thirds have no significant savings. One financial expert has called it "a catastrophe in the making."
It isn't true, of course, that they aren't saving. A couple making $60,000 a year will pay $4,590 to support Social Security and Medicare, matched by an equal amount from their employers.
It can't happen, our politics won't permit it, but suppose that young couple had "ownership" of their $4,590 annual contribution to Social Security. For simplicity's sake, let's assume from age 25 to 65 they make the same $60,000 a year and Social Security taxes aren't raised. With a compound return of only 7 percent, at age 65, they would have $1.1 million standing to their credit!
At least one group of Americans has more faith in UFOs than Social Security. A recent poll says that only one-fourth of those Americans between 18 and 34 believe Social Security will still exist when they retire, compared with 46 percent who believe in unidentified flying objects.
They have it wrong, of course. Unless there's a confluence of disaster, Social Security will still be around to serve them. The problem is they will have paid four or five times over for what they're likely to receive.
In writing my annual financial column last year, I said the Federal Reserve was summoning the courage to "nudge" interest rates higher. In fact, the Fed raised rates six times in 1994 and the value of old bonds declined significantly in price to compete with new paper at higher rates.
The experts keep telling us that stocks do better over time than bonds. Taken as a whole, they certainly do, and you can buy mutual funds that track the broad market. But there are two flaws here. First, you may own the ones that go down, or rise only slowly. Second, stock dividends are generally a lot less than the interest paid on the same money invested in bonds. So, your stocks will have to double in value every seven or eight years to equal the return on bonds.
While you always want to be on the sidelines when rates are rising, the better to step into the market when older bonds are heavily discounted, the good news about bonds is they generally come back to par at maturity, if not before.
It's virtually certain the Fed will soon raise rates again, it has as much as said so. But that is already factored into bond prices. While the recent elections and various polls show people far from satisfied with the economy, I see evidence of considerable strength and more than one additional rate increase. But we can't be too far from a buying opportunity in bonds and certificates of deposit if for no more reason than substantially higher rates will bust the federal budget.
To get down to cases, what should our mythical couple do? If they qualify for an independent retirement account or other tax-deferred plan, they should take maximum advantage of that before they do anything else. They can each contribute $2,000 a year to an IRA, deductible from income, which means an immediate savings in federal taxes of about $800. And everything earned in their IRA will compound tax-free until withdrawn.
That tax-free compound can work wonders. If they do this religiously every year between age 25 and 65, at an average yield of 7.5 percent, they will accumulate roughly $1 million. And higher yields will produce dramatically higher final totals. These are now available in bond funds specializing in the paper of companies with relatively low credit ratings.
Your security is a diverse portfolio under professional management consisting of dozens of companies. Two that I own are Putnam Managed High Yield, trading on the New York Stock Exchange at about $11.65 a share yielding 11.40 percent at that price, and Smith Barney High Income, trading at just under $10 a share yielding 11.70 percent.
While shares in these funds will go lower if rates rise significantly, you are compensated for that risk by yields nudging 12 percent and shares selling at a substantial discount to the value of the underlying bonds. When interest rates fall, share prices should rise, but your return will likely continue unchanged for a considerable period.
If your combined federal/state tax bracket exceeds 25 percent, you would certainly want to look at tax-exempt bonds. These would not be suitable for an IRA or other tax-deferred plan. High-quality Virginia tax-exempts can now be had at discounts to par yielding close to 7 percent when held to maturity.
There are also excellent tax-exempt funds containing only Virginia bonds, which means all income is totally tax-exempt. You would need to get at least 10 percent interest on a taxable bond to equal the prevailing tax-exempt yield, and you won't find one that does that with credit quality comparable to many fine Virginia bonds or funds.
For those in higher tax brackets who have fully funded any tax-deferred pension plans available to them, these are truly superb investments, though you might want to wait until the air is thick with talk of the Fed raising rates a second time in 1995. A difference of only a quarter percent in yield on paper held a number of years can add up to a significant sum.
Ray L. Garland is a Roanoke Times & World-News columnist.
by CNB