The return on your savings account, money market account or certificate of deposit is probably hovering at 1.7% (see below), but what if you could boost that return to 3.4% or more? You would double the returns on your short term investment!
In the spring of 2008, consumers were saving less than 1% of their income. But then the economy headed south and savings headed north to where Americans were saving over 6% a year later. In fact, as a nation, we saved 5.6 trillion dollars last year. But wait! That’s not all the good news—there’s more! Inflation is projected to remain relatively low for the next five years, hovering around 2.5%. This means that all those people who have been saving money have a legitimate question to ask—what should we do with our savings? If you put it in your basic checking account, you will lose money due to inflation, but how do you make it grow without risk? I was recently on ABC NEWS NOW to discuss this problem and here are some of the highlights:
Q. Ellie, many of the people who are putting away 6% of their income are saving for a time in the near future when they feel comfortable enough to spend again. What are some of the things that these savers should not do with their money?
Ellie: I think it’s just as important to know what not to do with your money as it is to know what to do with that savings. If you are like most of those savers, you’re saving for the short term—at least temporarily. So that means you should not tie up your investments in stocks. If in the next three to five years, you plan on starting a business, buying a home, sending a child to college or buying a car—you should look at short term investing and not long term. There is a difference between funding long term investments, such as retirement and saving cash that you might need in the next three to five years. Second, you should not put these short term investments into money market accounts or traditional CDs because the money sitting in these low yield accounts, when weighed against inflation are basically making you nothing. When you do the math, you’ll see that a basic account making around 1.7 % interest, after you pay taxes on the growth and then adjust for a 2.5% inflation rate, is losing you money. In fact, that $100 you now have will be worth $98.60 next year.
Q. Then where do we start and if you are advising savers to avoid putting their short term savings into a savings account, then where do they put it to protect the principle and make the money grow?
Ellie: High Interest Bearing Checking accounts are a good place to start. In the past, these kinds of checking accounts haven’t been worth the effort. But recently, some financial companies have responded to the economic situation and they have found a way to still make money by allowing you to earn money as well. These kinds of high interest bearing checking accounts can usually be found in small to medium sized banks and some of them are paying 4% interest, which is 30 times what you could make in an average checking account or money market account. You can go to http://www.checkingfinder.com/ to find one of these kinds of accounts. An example of this is Royal Banks of Missouri, that pays 4.3% on balances up to $24,999 and 1.4% on balances over that maximum. There is a catch, however, you must use your debit card at least 10 times during the statement cycle, make at least one direct deposit or an automatic payment per month and then receive your statements online. If you don’t meet ALL this criteria, the hit is a big one because you’ll only earn .15% on the entire balance for the month.
Q. So a High Interest Bearing Checking account is one way to double your return. If we’re not having much luck in average money market funds and traditional CDs, then is there another kind of CD out there that might help those who want to double their return?
Ellie: As a matter of fact, you can look at some of the nontraditional certificates of deposits to get a better rate. First, look for the introductory teaser rate which are found at bankrate.com or ratebrain.com. I found some for 4.3%. You’ve seen the teaser rates for credit cards and these are basically the same kind of offer—they have limitations and stipulations and if you want them to work for you, then you’d better know what those boundaries are. Most of these introductory CD rates are from banks who want to boost their deposits by offering a drop dead gorgeous interest rates. As long as they are FDIC insured, you don’t have to worry.
Q. In the past, it’s been wise to ladder your CDs, is that still true, even with the nontraditional certificate of deposit?
Ellie: Yes, the laddering concept is still the same. Basically, you’ll divide your CD money into four or five pots of money, then invest the portions into CDs that will come due over the next five years. That way, when interest rates rise (and they will) then you won’t have to wait five years to take advantage of the higher rate; you’ll be able to roll over the CD that matures next. This strategy also gives you more access to cash, should need it.
Q. One of the new nontraditional CDs that can give you twice the return at no risk is called a STEP-UP product. How does this work?
Ellie: This is a new kind of product that offers longer maturing CDs at a higher rate for each year that you hold the certificate. The first year, it may offer a 1% return, but in years two and three, you could see it rise to 2% and in the fourth and fifth years it would be 4%. They are FDIC insured and you will need to buy them through your brokerage firm. But the good news is that you do not pay the commission, the issuing bank will cover that amount. However, if you want out of the CD early, you could go back to your broker and they could try to find someone to buy them from you, but in that case you would be the one paying the broker’s commission.
Q. A second kind of non-traditional CD is called a “Structured” CD, how does it work and are they a better option than a traditional CD?
Ellie: The returns on a structured CD are tied to an index (such as the S&P 500) or they could be tied to currency movements or inflation. You are guaranteed not to lose money should the index decline, which is nice but if it goes up, you’ll only get to take advantage of a part of that gain. So if the S&P goes up 10%, you may only get 6%. While some of these are FDIC insured, others are insured by the bank. I recommend the FDIC insured variety.
Q. Most of those who saved a part of that 5.6 trillion dollars last year, are short term investors who are saving to buy a car, house, or pay for college. While some aspects of the bond market have been attractive in recent months, is there a short term bond investment that will still allow savers to double their returns with no risk?
Ellie: There is a group of short term bonds that invest in municipal and corporate bonds and these can earn up to 4% and 5% in returns! Like our nontraditional CDs, these are also purchased through a brokerage firm, but as with any kind of a mutual fund it is a good idea to check the fund’s rating at Morningstar.com. Not all of these funds are created equal and some are better than others. Of all of the returns we’ve talked about so far, this investment option is the riskiest. Sometimes the bond market performs well and sometimes it doesn't, that's the risk you are taking for the higher return in this case.
America's Family Financial Expert (R)