October 6, 1997

Q. I am an 80-year-old widow. My monthly income from pensions amounts to $1,800, and I get another $670 quarterly from an annuity. I have $40,000 in CDs and about $9,500 in savings and checking accounts. I am in the process of selling my primary residence and will probably realize about $120,000. I would like to invest this to augment my monthly income. I am not too knowledgeable about the stock market, but I realize that if I invest at my age I should be in conservative mutual funds. From my reading and listening, I have come up with three funds that appeal to me -- AARP GNMA and US Treasury, Vanguard GNMA, and Vanguard Index 500. Are these wise investments for me? If so, how should I divide the money? Should I put the funds in a money market account and gradually buy fund shares on a monthly basis? Can I reach these companies by telephone, since I would prefer not to use a broker?

B.R., Lynn

A. Sure you can. You can get a toll-free number for these companies -- and most other mutual fund companies as well, simply by calling 800 information (1-800-555-1212). Since both of these are no-load fund companies, a broker wouldn't be interested in helping.

As for your choices, I'm with you two-thirds of the way. I'm pretty sour on the stock market and on the large-cap stocks that dominate the portfolio of Vanguard Index 500 in particular. These are the stocks that have enjoyed the spectacular runups of the past few years, and in terms of yields and earnings power, I don't see a great deal of room for these stocks to grow over the short term -- and by short term, I mean within five years. Moreover, since the yield of Vanguard Index 500 is a paltry 1.6 percent (which reflects just how expensive these stocks have become) an investment there wouldn't do much to augment your income stream.

Vanguard GNMA and AARP GNMA and US Treasury are both very solid funds, designed to serve as long-term holdings for people in your situation. Both invest in federally guaranteed securities, with the Vanguard offering sticking entirely to government-guaranteed mortgages, and with AARP's fund combining mortgages with Treasury securities. In the latter case, this tends to reduce yield, with its 6.4 percent 12-month payout comparing to 7 percent for Vanguard GNMA. In theory, the AARP fund should be safer, with a shorter-term portfolio duration, and should thus have a lower payout. But it's hard to prove this by the numbers. Funds such as these tend to have about two tough years every decade, and the last 10 years have been no exception. The weakest years for these funds in the last decade were 1987 and 1994. In 1987 AARP GNMA and US Treasury gained but 2.73 percent, and Vanguard GNMA returned 2.15 percent; in 1994, both lost money, with the AARP fund off 1.68 percent and Vanguard's losing 0.95 percent. The overall 10-year record shows average annual gains of 7.99 percent for AARP GNMA and US Treasury and 9.23 percent for Vanguard GNMA.

How to divide the investment? The first thing you should consider is that any bond fund can be a terrible short-term investment. Because of the volatility caused by interest rate swings, you shouldn't put any money in bond funds if you don't expect to leave it there for five years or more. So if you think there's a chance you will need to draw upon some of this capital, I would estimate the amount you might need and either invest that in a money market fund or in six-month CDs. As for the rest, I suggest two-thirds in Vanguard GNMA and one-third in AARP GNMA and US Treasury.