With interest rates uncertain, a short-term strategy may be wise

For several weeks now, customers have been coming into Chicago's Harris Bank & Trust Company looking for new places to put their money, says Michael Wixstead, a vice-president and savings product manager at the bank. They're not happy with what they find. ``They come in with 21/2-year CDs that were earning 15 percent or more,'' he laughs. ``They're in shock.''

The shock comes from the fact that rates on one-year certificates of deposit are running less than 8 percent, although compounding pushes the annual effective yield to 8.2 percent, but still carrying a 45 percent loss in yield. A new 21/2-year CD would earn a little more, but few depositors want to tie up their money that long, believing interest rates may not go much lower.

At the same time, rates on money market deposit accounts are under 7 percent, while the Donoghue Money Fund Average last week stood at 7.26 percent, its lowest yield in nearly seven years.

The overall decline in interest rates, while heartening for home buyers and businesses, has made it more difficult for savers to find high yields and has led to a feeling that the days of historically high ``real'' rates of return -- what money earns after inflation -- may be over.

``If people look at what's available now, they've got to conclude it's a different world,'' Mr. Wixstead notes.

``We're finding resistance'' to lower rates, agrees Peter Hegel, portfolio manager at American Portfolio Advisory Service, a subsidiary of Van Kampen Merritt, a Naperville, Ill., brokerage. Mr. Hegel's firm manages Van Kampen's three mutual funds.

``People have been spoiled because they've been able to get well over 10 percent, even on a tax-free basis, for several years,'' he says. Although inflation has stayed around 4 percent for more than three years, yields of 10 or 12 percent meant real rates of return of 6 to 8 percent. That's why savers express disappointment with after-inflation returns of 3 to 5 percent, even though this isn't that bad in historical terms.

Bank customers, for their part, are almost all reacting to lower rates in the same fashion: They are choosing short-term savings to avoid having money locked up when interest rates move up again. ``A lot of money is going into daily access accounts and three- and six-month CDs,'' says Patricia Tolliver, assistant vice-president of the Glendale (Calif.) Federal Savings. ``People don't believe rates are going to stay down.''

If the opinions of economists polled recently by the Wall Street Journal are accurate, short-term rates will edge slightly higher in the second half of this year, which means people following a short-term savings strategy are on the right track. You will get a higher yield on a 2- or 21/2-year CD, but if rates go up again, you'll either be left behind or pay a penalty if you try to get out early.

Still, many people do have some money they may wish to tie up for several years. If you are in this group, and you also want government guarantees, you might consider US Savings Bonds. As long as they are held at least five years, Series EE bonds pay 85 percent of the yield on five-year Treasury securities in the previous six-month period. This means the current rate on EE bonds is 9.49 percent. Also, the yield can never go below 7.5 percent, regardless of market rates. Again, you have to hold them at least five years to get even this rate.

The search for higher yields is also being felt in the mutual fund business, where money market funds are still taking in deposits at a heavy rate, despite lower yields. There appear to be two reasons for this. First, when rates are falling, money-fund yields decline at a slightly slower pace; and second, people often ``park'' cash in money funds while they look for other investments in a fund family.

A popular fund now is one that concentrates on mortgage-backed investments. A fund of this type offered by Fidelity Investments of Boston is paying a little over 11 percent, says Heidi Proctor, assistant product manager for fixed-income investments at the firm. The fund's portfolio contains mortgage-backed certificates offered by the Government National Mortgage Association (``Ginnie Mae''), the Federal Home Loan Mortgage Corporation (``Freddie Mac''), and other providers of money for home loans.

Even though they come through mutual funds, the certificates in the portfolios are guaranteed by the US government and, being in a fund, are subject to less volatility than individually owned Ginnie Maes would.

For those who can stand the prospect of a little more volatility, several fund companies, including Van Kampen, Colonial, IDS, and Massachusetts Financial Services, have introduced funds of high-yield or ``junk'' bonds. Massachusetts Financial's fund was so popular, in fact, the company had to close it at the end of June.

With Van Kampen's Tax Free High Income Fund, ``we're looking for relatively undervalued securities,'' Mr. Hegel says, ``instead of looking for well-known mar- ket names that may or may not be turnaround situations.'' The bonds in the highly diversified portfolio may be rated as low as B by Moody's or Standard & Poor's, Hegel points out, or they may not be rated at all. No rating often simply means the issues are too new to have been reviewed for a rating, but the issuer is willing to pay a little extra to get them on the market soon.

The Van Kampen fund had an initial underwriting a few weeks ago, and will be open to all investors as of Aug. 1, he said. Depending on the makeup of the portfolio, Hegel expects the fund to provide a tax-free return of about 9 percent, or an 18 percent yield for someone in the 50 percent bracket.

While there may be more risks from investing in a fund like this, such as a more volatile net asset value or even a possible default of some of the bonds in the portfolio, the dangers will not so great if the fund is only one of several savings-investment vehicles.

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