By: Rich Cheever & Scott Thomas
Recent actions by the Federal Reserve (“Fed”) to help stave off a more serious coronavirus recession have made things difficult for savers. If we rewind the clock just over 10 years ago to 2008, we went through a similar situation, now known as the Global Financial Crisis, when the Fed cut rates to extremely low levels in order to boost economic activity. As we learned in Finance 101, low rates are great for borrowers as they can finance that home purchase or business investment at a lower interest rate. Unfortunately for savers and retirees those low rates can make for challenging times as the savings account, new CD, or current money market interest rates are almost certainly significantly lower than what was available a year or two ago. As a result, savings options that have long been a solid way to keep up with inflation now look less attractive. What can savers do with lots of assets in cash-like accounts to achieve higher returns without taking on too much risk?
When considering alternatives, it is important to remember that we counsel our clients to keep a solid balance in their bank for the peace of mind that goes with it, ease of access, and to serve as an emergency fund. We typically recommend at least six months of the cost of living have no risk of capital loss and be accessible within a day or two. Anything beyond an FDIC-insured bank balance, short-term CD, or shorter-term Treasury bill will tend to have some risk. As the old adage goes, “There is no free lunch” when it comes to earning the chance at a higher return.
That said, here are a couple ideas:
Short Term Bonds - Bonds are debt instruments that will pay you a set interest rate with your principal back at maturity. For dollars subject to capital gains and/or state income tax, municipal bonds, which often come with tax deductions on the income they generate, can be a good option. With bonds you may have interest rate risk and credit risk. As interest rates rise bonds will tend to drop in price as newer issued bonds offer a competitive interest rate. Staying short term can reduce this risk and return your principal in a shorter time frame. Also staying in high quality bonds such as US Government Agency paper or investment grade rated bonds will reduce credit risk, although there is a premium to be earned for those willing to take on the credit, or default, risk for less highly rated debt. The risk to any bond is that they will default on their interest payment or fail to return the full principal at maturity.
Equity Income Stocks – For investors who have a longer time frame and are willing to withstand more volatility, investments in corporations who return much of their profits to their shareholders in the form of a dividend can be a good option. Mature companies in the US and abroad can offer attractive dividend yields in excess of what is currently being offered at banks, but remember that with equities or stocks an investor is taking on economic and stock market risk.
We often get questions about better income options in this low interest rate environment, and here we’ve provided a very basic breakdown of two asset classes that can offer more attractive yields. At GBB we tend to favor mutual funds or ETFs which can offer an investor diversification, thus reducing any company specific risk. We also feel that it is important to work with a Financial Advisor with whom you can build a trusting relationship. That advisor can help you understand your risk tolerance in these uncertain times, and guide you through the investment landscape to help make sure your investment portfolio matches your objectives and fits with your appetite for risk. If you’d like to learn more, please reach out to your RCB Banker for a referral to a GBB Financial Advisor.