Bonds: How To Earn An Easy 5%

If you're like every other investor out there, I'm sure you're frustrated with the low interest rate environment for bonds. Well, here's an easy way to make 5% on your bond money. It just requires you to think differently about how you're allocating your savings.

Let's assume you have $10,000 earmarked for your retirement savings, and you want that money to go into some form of safe, fixed income investment. You go down to your bank and ask what sort of CD rates they have for 5 year CDs. You learn you can get a whopping 2%. But at the same time, you're also carrying a mortgage on your home at 5% interest, or maybe a bit higher.

So here you have $10,000 that you want to invest in safe, fixed income securities for the long-term, and the question is, what's the best long-term use of that money? Well, you can buy the CD and earn $200 a year for the next 5 years. But, you still have a mortgage out there at 5%, meaning that every $10,000 in mortgage debt is costing you $500 a year in interest.

Instead of buying the CD, you may want to simply apply that $10,000 to your mortgage. That will save you $500 worth of interest each year, and you'll come out $300 ahead. Paying down the debt has a similar economic impact on your finances as earning 5% on your money because that's the amount of interest you're saving by paying down the mortgage.

Think about it another way. Let's say you're 64 and going to retire next year. We'll also assume you still have a $100,000 mortgage at 5%, but have $100,000 rolling over in a CD next month. This $100,000 CD is part of your overall retirement savings. If you keep the money invested in the CD at 2%, it generates $2,000 of interest. If you take it and pay off the 5% mortgage, it saves you $5,000 of interest, and you come out $3,000 ahead.

• Eventually, you need to get the house paid off before you retire, and paying down your mortgage should be part of your long-term retirement savings plan.

Because the gap between what you can earn on your fixed income savings and what it costs to carry a mortgage is so high (it usually isn't this large), you may be better off paying down the mortgage faster. You can do it in a lump sum, or you can do it by increasing your monthly mortgage payment. Either way, you're implementing the same strategy of taking money that you would otherwise invest in low-yielding fixed income securities and using that money to reduce higher interest debt, which in the long run has a positive impact on your ability to retire.

• You want to of course check that you don't have any sort of pre-payment penalty on your mortgage, and the vast majority of mortgages don't.

You should only consider doing this with fixed income investments that you have identified as long-term holdings primarily for retirement. If you have a need for short term cash, then you should keep that money in safe and liquid short term investments.

Bottom line. With interest rates so low, you may be better off using some of your fixed income retirement savings to pay down your mortgage debt.

Learn More: Want to learn about a simple way to manage your personal finances and prepare for retirement, investigate my new book Your Money Ratios: 8 Simple Tools For Financial Security, available in bookstores and at amazon.com The Wall Street Journal called the book "one of the best finance books to cross our desks this year." WSJ 12/19/09.

Above material does not constitute financial or tax advice. Consult your individual advisor prior to making any financial decisions.

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