The Best New Savings Vehicle You’ve Never Heard Of

Floating-rate notes may be a smart investment as interest rates rise.

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Barbara Friedberg
Barbara Friedberg

What retiree isn’t upset with the low interest rates? Current retirees remember the good old days when certificates of deposit paid 12 percent and money market funds were raking in 8 percent to 10 percent year after year.

You may have conveniently forgotten about the rampant inflation of the early 1980s. But even factoring in inflation, the real return (stated return minus the inflation rate) left savers with approximately a 3 percent return during most of those years. That 3 percent is a far cry from the near zero percent real return we’re receiving for saving today.

Back in the day, savers were happy with government bonds paying 12 percent interest. If you had loaded up on 30-year bonds in the late 1970s and early 1980s, you would’ve doubled your money at least three times before the bonds matured in this century.

There is hope for savers, however. According to Louise Yamada of Yamada Technical Research Advisors in New York, the 222-year average interest rate is 5.81 percent, and we are currently at a generational interest rate low.

What does this mean for savers? The future looks brighter. At some time in the near future, interest rates will increase. That puts savers in a bit of a bind.

Savers don’t want to buy a long-term bond or CD, only to watch interest rates trend upward. If you buy a five-year CD today, you might be lucky enough to earn a 2 percent annual return. How would you feel if you tied up your money at 2 percent for five years only to see market rates move up to 4 percent in the second year? There is a solution for savers: floating-rate notes.

Just like the U.S. government’s ingenious inflation savings bonds, or I-Bonds, which protect the saver’s principal from inflation, these new government floating-rate notes promise to rise along with increases in interest rates. No more worries about tying up your money. When interest rates rise, so will your returns. Here are three things to know about floating-rate notes:

How do floating-rate notes work and where do I get them? Floating-rate notes have an interest payment that fluctuates with changes in market interest rates. The rate is pegged to the interest rate on the 13-week Treasury bill rate. When interest rates go up, so does the return on the floating-rate note. Conversely, when interest rates fall, so will the note’s return. Interest is paid and reset quarterly.

Floating-rate notes offer tax advantages as well. Similar to I-Bonds and the Treasury’s inflation-protected securities, the interest is exempt from local and state taxes.

Investors can buy floating-rate notes for as little as $100 and up to $5 million. At maturity, the floating-rate note can be redeemed for face value. Floating-rate notes may be purchased from treasurydirect.gov beginning in January 2014. These investments may also be purchased through a bank or investment broker. To be eligible to purchase floating-rate notes through treasurydirect.gov, the consumer can set up an account. This account also enables the owner to buy other government securities such as I-Bonds, TIPS, Treasury bills, notes and bonds.

What are the current interest rates for floating-rate notes? Since the first auction isn’t live until next year, you won’t receive any returns right now. But it’s easy to predict the approximate level of interest rates by looking at the 13-week Treasury bill yield. As one would imagine, the recent return on 13-week Treasury bills issued on Dec. 19, 2013, was 0.066 percent. This is not a particularly exciting rate, but with the Federal Reserve poised to stop quantitative easing, its massive bond-buying program, interest rates will eventually rise. In fact, rates are already inching up. Buy the floating-rate notes now, and you don’t need to worry about missing out on higher returns when interest rates finally rise.

Why haven’t you heard of floating-rate notes? Financial advisors who are compensated by commission aren’t quick to inform their customers about these investments. The government doesn’t pay a commission to investment advisors. Thus, you won’t hear about floating-rate notes from most financial salespeople.

If you can’t wait until January, consider buying an I-Bond from treasurydirect.gov. These investments are pegged to inflation and protect your purchasing from the ravages of inflation.

Barbara Friedberg, MBA, MS is a portfolio manager, consultant, website CEO and author of “How to Get Rich; Wealth Building Guide for the Financially Illiterate.” Learn more about investing at Barbara Friedberg Personal Finance.