Zero-Coupon Bonds: A Safe Alternative For Retirement


The one immutable law of investing is that the higher the potential gain, the higher the potential risk.

Many people find that the closer they get to retirement, the more they are unwilling to stick out their necks for higher returns. After all, they're going to be needing that dough to spend on their condo, food and their grandkids' braces.

High quality bonds are a good investment for people nearing retirement as they offer rates of interest well above those on certificates of deposit and guaranteed investment contracts offered by insurance companies. But the trouble with bonds are the interest payments. Sure, it's nice to get a check in the mail, but if you don't need it immediately, what do you do with it? Reinvest it, of course. The problem is that interest rates may have dropped sharply and you would be forced to buy a new bond that is paying a low rate of interest.

For those who want to avoid this problem yet still want a decent return with a fair amount of security, they need look no further than Uncle Sam.

The U.S. Treasury sells zero-coupon bonds, which, like normal bonds, promise to repay the principal at a certain date. But unlike normal Treasury bonds, zero-coupons don't pay interest as the bond matures. You buy zero-coupon bonds at a discount to their final maturity value and profit as the discount narrows. Zero-coupon bonds have another advantage as well; they can't be paid off early as many corporate bonds are. Their risk of default is also virtually nonexistent as was recently seen in the budget battle between Congress and the White House. Treasury Secretary Rubin merely raided the pension funds of federal workers to make good on Treasury securities.

But don't think about selling zero-coupon bonds before their maturity date as they can fluctuate in value just as much as ordinary bonds.

You can buy zero-coupon bonds directly from the Treasury with no commission or through any stock broker.

Although that's the cheapest way to buy them, it's easier to get into this investment by buying shares of a zero-coupon bond mutual fund. That's because you probably can't afford to buy many bonds but you probably can afford to buy the shares of a mutual fund.

Benham Group's Target series of bond funds, for example, invests in zero coupon bonds. They have six funds each with bonds expiring in different years: 1995, 2000, 2005, 2010, 2015, 2020. In the five years ending the third quarter of 1995, the funds' average annual return that ranged between 12.3 percent and 18.5 percent, well ahead of their competitors. Other mutual fund companies, such as Dreyfus, offer similar zero-coupon funds.

Bottom line: zero-coupon bonds are good for your stomach and good for Uncle Sam.

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