I have an 88-year-old friend who had a $40,000 certificate of deposit come due. The nice young man at the bank commiserated with him about the low interest rate CDs pay these days – lower still after tax – and suggested that he put his money into the Rochester Fund instead. ‘It pays 5.75% tax-free,’ explained my old pal when he called – what did I think?
I thought I had better look into it.
And sure enough, checking Morningstar, one learns that this is a fund that invests primarily in very long-term New York tax-exempt bonds, mostly maturing between 2020 and 2039 (which makes them risky if the general level of interest rates should rise). Only a third of them are rated AAA or AA (which makes the other two-thirds less than ironclad).
If the general level of interest rates should rise, the value of a bond maturing in 2039 plummets. Not good if you should want to sell the bond before maturity. Meanwhile, if the general level of interest rates should fall sharply, the value of your holdings rises – but not as much, because most bonds in this situation would be ‘called.’ Just as you would refinance your house if mortgage rates plunged, so do municipalities call in their too-generous bonds and replace them with lower-interest ones. So if rates go up, you get clobbered; and if they go down, you don’t gain much. It’s ‘heads I win, tails you lose.’
Meanwhile, if one or two of the lower-rated bonds Rochester Fund holds should default, that would hurt, too.
(Even the AAA bonds raise the question – which I hope we never have to see answered – of what would happen in a really terrible economic collapse. Many of those AAA bonds have their AAA ratings not because the issuer is rock-solid, but because the bond issue has been ‘insured’ by one of a couple of giant insurance companies in this business. Well, fine, but who insures them? If a single bond issue went bad, no sweat. But if it were a more general problem, bringing hundreds of municipalities to their knees, what good would this insurance be? My guess is that we’ll never have to find out, because the real insurer, in that sort of situation, would be Uncle Sam. The government just wouldn’t allow an economic collapse so severe it would bring down the muni-bond insurers. But one never knows.)
All this worrisome stuff falls into the No-Free-Lunch Department – and I can live with it. Municipal bonds rarely default, even if they’re only rated A or BBB. (Rochester Fund also has 2.4% of its money in BB and B bonds, and 20.5% in unrated bonds. But unrated bonds are generally unrated not because they’re bad, but because they’re tiny issues, not worth the issuer’s money to get rated.)
What I cannot live with are the sales and expenses charges the bank didn’t mention to my 88-year-old friend.
My friend, I should mention, is smarter than a college-full of kids. But he is 88. It’s a little hard for him to hear and a little hard for him to see. So if the nice young man at the bank tells him something, he may not rush to read the fine print.
The fine print reveals a 4.75% sales charge on this fund – meaning $1,900 of his $40,000 would be lost immediately in a sales fee – and then a .74% annual expense fee – in this case a further $300 or so a year.
It is not a coincidence that the bank recommends a fund with a high sales fee and high expenses. The bank gets a piece.
Rochester, one of the Oppenheimer family of funds, offers this fund with two other pricing plans, including one with NO load but a 1.59% combined annual expense ratio.
With safe tax-free bonds yielding 4% or 5% these days, to pay 1.59% in annual expenses is to give up about a third of the yield. Why do that? Why not just buy bonds directly, through a broker. You won’t need diversification if you buy ‘general obligation’ bonds of a state or major city, which are almost surely safe. And you’ll be able to select exactly the maturity that fits your plans. Just be sure to shop around for a decent price on a widely-traded issue. Nothing obscure that will be hard to sell at a fair price. Something issued in great quantity, and thus traded often. (Of course, if you select a bond that you hold until redemption, there will be no selling costs.) Or call Vanguard and invest in a tax-free bond that’s both no-load and low expenses.
How many octogenarians had CDs come due last month? A lot, I’d guess. And how many of those found themselves advised to roll them over into the Rochester Fund and its ilk? A lot, I’d guess. It’s how the world really works.
Quote of the Day
Every gun that is fired, every warship launched, every rocket fired signifies, in the final sense, a theft from those who hunger and are not fed, those who are cold and are not clothed. The world in arms is not spending money alone. It is spending the sweat of its laborers, the genius of its scientists, the hopes of its children.~Dwight D. Eisenhower, 1953
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