Zero-coupon bonds offer savers a new way to feather the nest
In the jungle of the investment world, some new financial animals with names like CATS and TIGRS are being touted as the latest thing for individual retirement accounts (IRAs), pension plans, and college savings.
The animals are more commonly known as ''zero coupon bonds,'' and as their name implies, these bonds have no coupons to clip. Instead, they are bought at a discount, sometimes as much as 75 percent off face value, but more often at 50 percent off. The bonds issued by brokerage houses are collections of government-issued certificates pooled into ''zeros'' by the firm. At the same time, several corporations in need of cash are issuing zeros of their own.
Both types are similar to US Savings Bonds, which are also discount bonds that pay face value at maturity. Actually, the ancestor of zeros goes back to 1864 and the Civil War era, when the US government sold $50 bonds for $30 or $35 and redeemed them a few years later for the $50 face value.
Today's bonds, says John Cirigliano, head of product development in the corporate finance division of Merrill Lynch, Pierce, Fenner & Smith Inc., are designed ''to take advantage of a particular scenario in the bond market - historically high interest rates.'' Merrill Lynch's pet is called a TIGR, which stands for Treasury Investment Growth Receipts.
In addition to Merrill Lynch, several other firms, including Bache Halsey Stuart Shields Inc., are devising products to help investors profit from those high rates.
At Bache, says national sales manager David Saalfrank, their CATS (Certificate of Accrual for Treasury Securities) went on sale earlier this month. It is a collection of US Treasury certificates and notes purchased by the firm. The securities are then repackaged into CATS currently yielding 11.17 to 11.53 percent, depending on how long they are held, Mr. Saalfrank says.
If one of the CATS is purchased for $100, for instance, it will be worth $1, 000 in 21 years. The same growth rate applies to the larger denominations that are available, although $100 is the smallest CATS that can be bought at Bache, Mr. Saalfrank said.
''They are particularly good for people who are 'nest-egging,' '' he says. This would include people saving for a child's college education or setting up individual retirement accounts. They would also be useful for corporate-pension or private-sharing plans, where the company can invest the money and know exactly its future value when pensions are to be paid.
For individuals, if zero-coupon bonds are purchased as a regular investment - that is, not for an IRA - the interest income must be reported annually, even though the investor is not getting the money until the bond matures.
But if the zero is used as an IRA vehicle, this reporting is not necessary, because the tax liability is deferred until you need the money, when you presumably will be in a lower tax bracket. Also, you know the interest rate will stay the same throughout the life of the bond. Locking in an 11 percent rate for 10 to 21 years may be attractive.
Merrill Lynch, Mr. Cirigliano says, began selling its TIGR in the middle of August, after working on it for more than a year. In the first month, more than
In addition to CATS, TIGRs, and other creatures sold by brokerage houses, several corporations began selling zeros about a year ago. Like the brokerage-house animals, the corporate versions are sold at a discount. They are also sold through brokers. While they have similar returns, some financial advisors are urging caution.
For one thing, points out Marian J. Karpen, vice-president at Warburg Paribas Becker, several of the companies may have trouble paying them back - or may be in bankruptcy - in five years.
Also, she says, zero-coupon bonds are such a new ''gimmick'' that people should wonder if there will be a market for them in five years, should they want to adjust the contents of their IRA. Buyers of these bonds, she adds, are assuming the long-term stability of the issuing corporation, something you may not want to do with a retirement kitty.
''That's why we have rating services,'' counters Mr. Saalfrank of Bache. Any zeros issued by a corporation, he says should at least have an ''A'' rating (investment grade) from Standard & Poors.
Still, people thinking of using zero-coupon bonds for their retirement savings should make them just one part of a diverse investment strategy. A TIGR may be a beautiful animal, but you don't want to get clawed.