Should You Buy Floating-Rate Notes?
Aug 24th 2012 5:00PM
Updated Aug 24th 2012 5:02PM
The yields offered by banks are laughable. Checking and money market accounts are yielding roughly 0.50% per year. Five-year CDs are slightly higher at 1.50% -- still, not very impressive.
This situation got several well-known companies thinking, "Let's sell debt to consumers who recognize and trust our brand, and offer interest rates on it that are slightly higher than these CDs and money markets."
Thus, the "floating-rate demand note" was born.
For a minimum investment (some as small as $500), individuals can now buy portions of corporate debt from well-known companies like General Electric (GE), Caterpillar (CAT), Ford (F), and Duke Energy (DUK).
The idea itself doesn't seem all that bad. And the rates each company is offering are indeed better than most bank accounts':
But it's what you're not told that's discouraging
First of all, these yields can't accurately be compared to a bank account's yields.
These new offerings are investments in a company's debt. So unlike checking and savings accounts, CDs, and money market deposit accounts, which are all insured by the FDIC for up to $250,000, investments in floating-rate demand notes do not carry a similar guarantee.
Even more alarming, money market analyst Peter Crane recently pointed out to Bloomberg BusinessWeek, "if the corporation defaults, investors' money will likely be tied up in bankruptcy court, and they might lose a significant portion of their investment."
But perhaps the worst part of these new offerings is that folks who are looking for long-term yield would be much better off investing in each company's stock and collecting their dividends.
In fact, buying the company's stock is both more attractive on yield basis alone, and it offers the possibility of long-term growth (as well as long-term dividend growth). This is in comparison to a fixed rate of principal return and a low, fluctuating interest rate that comes with these floating-rate demand notes.
And each of these companies has a strong, growing dividend
General Electric's stock yields 3.3%, and it recently upped its quarterly dividend payment by 13%.
Similarly, Caterpillar's stock yields 2.5% after a recent 13% boost as well -- its biggest increase since the financial crisis.
Ford is yielding 2.2%, not long after paying its first dividend in more than five years. Part of this high yield is admittedly because of a falling share price, but demand for the company's vehicles is strong, so Ford should continue to be a long-term performer.
Finally, Duke Energy carries a monster 4.5% yield. And, quite similar to many of the others, recently increased its dividend. In fact, it has done so "every year since 2007," according to CEO Jim Rogers.
Buy the stock, not the note
As you can see, every single one of the companies offering floating-rate demand notes have even more impressive dividend yields with a recent history of growing.
And, as mentioned earlier, buying actual shares of these companies simultaneously hands you the possibility for capital appreciation (since each of these company's stock price should rise over time.)
So if you're looking for a strong yield over a multi-year timeframe, stay away from these alluringly marketed floating-rate demand notes. And look to blue chip stocks with strong dividends instead.
Motley Fool analyst Adam J. Wiederman owns no shares in the companies mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of and creating a synthetic long position in Ford.