Holders of Maturing CDs Face a Difficult Call

It’s decision time for many holders of certificates of deposit: October is one of the two biggest months for CDs to mature. But thanks in part to Saddam Hussein and Alan Greenspan, choosing where to put your money seems as tough as ever.

October is a big month for CDs to mature, largely because six-month and one-year CDs are the most popular maturities, and savers in recent years have tended to open up CDs in April or October.

April has been popular because many people deposit their income-tax refunds. October is popular because CD rates were deregulated in October, 1983, resulting in higher rates that attracted many savers at the time. Also, many people pulled money out of stocks and put it into the relative safety of banks following the October, 1987, market crash.

Altogether, some $130 billion worth of CDs are expected to mature this month. But the decision to roll over your CD into a new one is not a “no brainer.”

Guessing the direction of interest rates--at least for the short term--seems like a real crap shoot. Will Hussein’s actions trigger war in the Middle East? If so, rates will shoot higher, and you’d want to say no dice to locking in a rate now with a CD. But what if peace persists and Federal Reserve chief Alan Greenspan loosens credit to drive down interest rates? Then you might want to lock in a rate on a CD or roll the dice by investing in long-term bonds.

“In the long run, interest rates will go down,” predicts Kurt Brouwer, president of Brouwer & Janachowski, a San Francisco money management firm. “But there is definitely so much uncertainty that I don’t think anybody knows where rates are going in the short run. You’re better off playing with your kids than trying to figure out where interest rates are going.”

The decision also is tougher because of the sick shape of many banks and savings and loans. You might want to shop more carefully for stronger institutions because you could lose your nice rate if your institution fails.

Also, with the economic recovery looking like it’s on its death bed and a recession seemingly on the horizon, even your job may not be so safe. Do you want to lock your money up in a long-term CD if you might need that cash soon just to pay the mortgage?

Here are some tips on the most common choices:

* CDs and other bank deposits. If safety of principal is your main concern, these will do the trick. Despite all you’ve heard about the troubles of the Federal Deposit Insurance Corp., which insures bank and thrift deposits, there is no way the government will let people lose money in accounts meeting the $100,000 insurance limit.

However, there is a risk: Your rate could be cut if your bank or thrift fails. That’s because when the federal government transfers deposits from a failed institution to a healthy one, the healthy one is allowed to offer you a new, lower rate. You can, of course, just say no and take your money elsewhere. But if, in the meantime, prevailing CD rates have fallen, you would be stuck with a lower rate anyway.

Therefore, it pays to shop for strong institutions offering good rates. Fortunately, such opportunities are not hard to find.

What if you want to lock in a high CD rate, yet also want the opportunity to withdraw your money in an emergency without incurring an early-withdrawal penalty? Consider brokered CDs sold through securities houses. You get the same federal deposit insurance as CDs bought from banks and S&Ls;, but you can sell brokered CDs through the securities firm.

Of course, another way to maintain instant access to your money is through a bank or S&L; money market deposit account or passbook account. But their rates are generally inferior to most other choices, such as money-market mutual funds and government securities.

* Government securities. Treasury bills can be ideal for conservative investors. They are safe--backed by the full faith and credit of Uncle Sam--and exempt from state and local income taxes (definitely an advantage in such high-tax states as California). Rates also compare favorably to CDs. Three-month bills are yielding about 7.3%; one-year bills are at about 7.5%.

Want a higher yield with a bit more risk? Consider longer-maturity Treasury notes and bonds. Thirty-year bonds are yielding about 8.8%.

But keep in mind that unless you hold notes and bonds to maturity, you could lose part of your principal should rates go up. The values of notes and bonds fall when rates rise. On the other hand, should rates fall, you could easily make total returns--yield plus price appreciation--well above 10%.

* Money-market mutual funds. These may be the best balance between safety, decent yields and liquidity. The average money fund is yielding 7.76%, and you can easily withdraw your money by writing a check.

Money funds are generally considered safe, but they are not as rock solid as CDs and Treasuries. Although no one has yet lost a penny of principal in a money market fund, they invest in commercial paper, a form of short-term IOU issued by big corporations. If the corporation issuing the paper defaults or has other financial troubles, the money fund will have to absorb that loss--or pass it along to you.

* Short-term bond funds. Go with these if you want a shot at double-digit yields in exchange for a bit more risk. They are paying slightly more than money market funds and have a chance at price appreciation should rates fall.

Be sure to stick to “no-load” funds, which don’t charge sales commissions when you buy or sell. Those charges will wipe out part of your return.

* Long-term bond funds. These are for gamblers who figure that interest rates will fall. If rates fall quickly and sharply--such as by two or three percentage points in less than a year--you could double your money. On the other hand, if rates rise, you’ll lose some of your investment.

* Tax-free bonds and funds. If you’re in the 28% or 33% individual tax brackets, consider municipal bonds or mutual funds investing in them. Their yields generally are superior to the after-tax yields of many money market funds and CDs.

For example, the average yield on tax-exempt money funds is 5.89%, which is equivalent to taxable yields of 8.18% and 8.79% for investors in the 28% and 33% brackets, respectively.