Saver's Lament

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Exactly two years ago, I wrote a column titled “Coping in a low interest World”. At the time, short-term interest rates were essentially zero and the benchmark 10-year Treasury yield hovered at around 2.4 percent. Soon after, 10-year yields plunged to 40-year lows of 1.4 percent as investors worried about the euro zone and the limp US recovery.

In the subsequent two years, yields bounced along historic lows, but starting last May, when the 10-year bottomed at 1.6 percent, yields have climbed a full percentage point, just above the rate seen two years ago.

The Federal Reserve has engineered these rock-bottom interest rates in order to boost the economy. In December 2008, the central bank slashed short–term interest rates to levels of 0 to 0.25 percent, a range at which rates have been for over five years. The central bank has also kept longer-term interest rates low by periodically purchasing bonds (aka “Quantitative Easing”) over the same time horizon.

While the Fed’s intentions were to help the overall economy, it’s clear that central bank policies have come at the expense of savers and that’s not likely to change any time soon – the best guesstimate would be some time in 2015. That time horizon leaves savers with a grim outlook.

There are actually two categories of savers: those who are seeking to increase the interest on their emergency reserve funds (at least 12 months of living expenses for retirees, 6 to 12 months for pre-retirees) and those who have used safe instruments like Certificates of Deposit (CDs), as part of their total investment allocation.

For emergency reserves, you should preserve the ability to access your money quickly. This is a concept known as “liquidity,” and it’s important regardless of your age, but even more so during retirement. Checking accounts, savings accounts, money market funds and 3-, 6-, 9- or 12-month CDs have all been the vehicles of choice for emergency funds. Interest rates for those instruments are currently around 0.5 percent, with larger account balances earning better rates.

You can try to find higher rates for your emergency reserves by turning to credit unions or on-line alternatives, which often offer higher rates.  The website, which keeps track of the best options among the various account types, is a good resource. Another idea worth considering is to purchase longer term CDs, with minimal 60-day early withdrawal penalties. For every $10,000 in emergency reserves, you may be able to increase your earnings by a couple of hundred dollars a year!

Two years ago, I suggested using Series I US Savings Bonds, which have two components: a fixed rate that remains the same throughout the life of the bond, and a variable inflation rate that is adjusted twice a year (May and November) based on changes in the Consumer Price Index. The first component has paid 0 percent for a few years now, but the second component currently earns a paltry 1.38 (down from 3.06 percent two years ago), which makes it hard to recommend an I-bond for either emergency reserve funds or for a fixed component of your portfolio.

What’s a risk adverse investor to do in this low interest rate environment? Sadly, if you really hate market volatility, you are stuck with reduced income. That’s bad news for retirees who were earning a lot more on their nest eggs before the Great Recession.

But if you are willing to add some degree of risk, you might consider adding short and intermediate term corporate bond funds in your retirement accounts; short and intermediate term municipal bonds for taxable accounts; and even a small percentage allocation into a stock market index fund.

Yes, stocks. I know that given the swings of the past decade, it’s tough to imagine, but if you can stomach 10-20 percent of your portfolio in a stock index fund and you are willing to live with the inevitable gyrations, you just may be able to goose the income of your portfolio without sacrificing a good night’s sleep.