Risk vs. reward is one of the classic debates of investing. This week, Sacramento, Calif.-based investment adviser Michael R. Tate answers a reader's question on safe returns.
QUESTION: I just reached age 70 1/2, when I have to start taking the required minimum distributions from my 401(k) account. My question is where to invest the withdrawals (about $6,000 annually)? I no longer have faith in the stock market, so I am interested in safe, short-term investments, possibly Treasuries or something that provides income (other than bank CDs).
ANSWER: You hit on a very important point: risk vs. reward.
In the current low-interest-rate environment, a very conservative approach would be in fixed-income investments, such as U.S. Treasuries, TIPS (Treasury Inflation-Protected Securities) or Ginnie Mae bonds. However, they're all paying close to nothing. When you take inflation into account, you may actually lose spending power each year.
Keep in mind, this will change over time. Interest rates will go up, and yields on these short-term investments will improve.
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For now, you have a few options, but even these come with some degree of risk to your principal. I would suggest using an index fund, due to its low cost and its ability to increase your diversification.
There are index funds through Vanguard, iShares, Fidelity and Charles Schwab, to name a few, that offer mutual funds that invest only in U.S. Treasury positions with very short maturities.
For example, I looked at the Vanguard Short-Term Treasury Fund (VFISX), which invests primarily in U.S. Treasury debt backed by the U.S. government. (This is not a recommendation; just an example.)
The average maturity was two years among the 41 bonds in the fund's portfolio. It also has a very low expense ratio of 0.22 percent. As of May 31, the one-year annualized return was 2.35 percent and the 5-year rate was 4.45 percent.
Not great but, considering the degree of risk, it's not a bad return in this environment.
And one last note, avoid any upfront sales charges and buy only no-load funds. That way, you can achieve your goals without paying commissions.
