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'Laddering' investments steps up income Varying maturities can increase return


New York --

If you're struggling to live on your savings, you'll recognize the distress behind this letter:

"My wife and I are both 65," the reader writes. "Our only income is from Social Security and the interest from $100,000, invested in a Treasury bill. We will not risk this money in anything other than Treasury securities, but the one-year rate is now below 5 percent. Should we switch to a 30-year bond for a better yield? We get $12,000 from Social Security and spent $16,000 last year, so we need $4,000 in interest."

A one-year, $100,000 bill is yielding interest of around $4,000, paid when you buy. A 30-year bond is yielding 7.7 percent, for $7,700 a year paid semi-annually. The extra $3,700 it earns could be invested to increase your capital.

I put this reader's question to financial planner John Allen of Arvada, Colo. Over the long term, he says, you'd earn much more from mutual funds that buy Treasuries (or other bonds) of varying maturities. But mutual funds fluctuate in value, which alarms some investors.

Another good option is a lifetime annuity. If you took half your money-- $50,000 in this case -- and bought an annuity from First Colony of Lynchburg, Va., to cover both your lives, it would pay $4,156 a year. That's everything you need right now. The interest you earn on the other half of your money could be saved to cover future inflation.

For investors who can't accept anything but individual Treasuries or certificates of deposit, however, here's how Mr. Allen votes:

He's against long-term bonds, which pose two serious risks.

(1) An income risk. For long-term bonds to supply enough income over your lifetime, three things have to happen: Your spending must stay level (with additions only for inflation); inflation can't get worse; and you have to invest each year's extra interest income, to increase your capital.

(2) A capital risk. If you unexpectedly need an extra slug of money -- say, for custodial care not covered by Medicare -- you'd have to sell the bond before maturity. Depending on market conditions, you might well get back less than you paid for it.

Mr. Allen also isn't crazy about one-year T-bills. If inflation stays at its recent 4 percent pace, you'd need $8,800 in 20 years to buy what $4,000 buys today. If you spend only income and not capital, one-year bills would soon leave you short.

It is possible to get more income from Treasuries without taking the risks of a long-term bond. Do it by "laddering." Split your $100,000 into, say, 10 $10,000 Treasury securities, each coming due in one of the next 10 years. You'll have a one-year Treasury bill, a two-year Treasury note, and so on. A discount stockbroker or trust company can set this up.

Three-year notes recently paid 5.4 percent interest; 10-year bonds were at 7.2 percent. Collectively, this ladder yields more than you'd get from short-term bills alone.

Each year, when a security comes due, take out capital you need and reinvest the rest in a 10-year bond. Ten years from now, you will have a 10-year bond coming due every year. The other way to improve your income is to spend principal.

For example, keep your $100,000 in short-term Treasuries at 4 percent and spend $4,000 on living expenses this year, which is the entire interest payment. Next year, you spend $4,160 -- which is $4,000 from interest plus 4 percent from principal to cover inflation. In each subsequent year you again raise your spending by 4 percent. Your capital would last 25 years. If you used a ladder to raise your return on investment to 6 percent, your money would last 34 years.

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