It's a lousy time to be a saver
With interest rates still hovering near historic lows and inflation ticking up,
conservative consumers stashing their money away in traditional bank accounts have been sorely
disappointed at the skimpy returns they're getting.
Worse, they've actually lost money over the last couple of years -- to the tune of over $300 billion by one estimate -- as inflation eats up the paltry interest, and then some, on most savings accounts.
"We've seen over the past year an increase in the year-over-year rate of inflation, but interest rates haven't budged," said Richard Barrington, an upstate New York-based freelance writer and personal finance expert for MoneyRates.com. "In fact, they've continued to slide down."
Most bank accounts now pay less than 1 percent interest, if they pay anything at all. Checking accounts are worse, with rates barely above zero. Even CDs are generating little in the way of returns.
At the same time, though, consumers are paying higher prices for food, energy and health care, as well as a host of other products and services, with much of it caused by oil prices. The rate of inflation is about 3 percentage points higher than interest rates.
"Not only are interest rates languishing at record lows, but it's coming at a time when consumers are beginning to feel the pressure of higher prices," said Greg McBride, vice president and senior financial analyst at Bankrate.com. And the weak economy and slack loan demand are "a recipe for more of the same," he added.
The combination has left savers in the unenviable position of watching the purchasing power of their savings erode, especially if it sits in the relative safety of a government-insured bank account.
"All that lost money, the interest that savers are no longer earning on their savings account, that's money that's effectively been taken out of the economy," Barrington said. "If you're a saver, and you used to earn 5 percent on it, you're the type of person who would have been in a position to spend some of that. Now you're not."
Barrington estimated that consumers lost $140 billion in purchasing power in 2009 and another $170 billion in 2010, all because "interest rates have been driven to a rate well below the rate of inflation."
So what's a saver to do to earn more off his or her nest egg?
There are options to increase returns from saving, although some of the better alternatives are also riskier. "You're not going to miraculously get 5 percent somewhere without taking risk," Barrington said. But "you can reduce the damage."
First and foremost, shop around, and don't let cash sit around in money funds. "Don't assume that the conditions you see at your bank are necessarily universal," Barrington said. "The banking market is very fragmented. You need to shop actively for a bank that has good interest rates."
Second, if you've just been using a regular checking account that pays little or no interest, at least try a savings account or money market deposit account. It's not much, but they do pay a bit more. And if they're offered at a bank as part of regular deposit services, they're easily accessible, and they should all be backed by the Federal Deposit Insurance Corp.
Or try a certificate of deposit, in which you effectively promise to keep your money at the bank for a certain period of time. The longer the term on a CD, the higher the rates usually. The risk here is that interest rates could shoot up over time, locking you into a rate that looks good now, but will seem unattractively low later.
And even with these methods, "you're still not talking huge gains. That's what you have to do just to get above 1 percent. The way things stand right now, you are still going to be losing some ground to inflation," Barrington said.
You could also try what are known as reward checking accounts or high-yield checking accounts. Typically found at community banks and credit unions, these accounts usually require customers to meet certain monthly requirements, such as using direct deposit, getting statements online or making 10 debit card transactions each month. But there's usually no minimum balance or monthly fee, and many accounts reimburse ATM fees.
However, while they can pay a higher rate -- 2.5 percent or more -- the best rate is usually limited to a certain amount of money in the account, such as the first $10,000 or $25,000. You can keep more in there, of course, but you won't earn as much on it.
Third, consider less traditional alternatives, such as online banks with their high-yield savings accounts and CDs. Web-only banks or online divisions of regular banks typically tend to pay more on deposits, because they don't have the heavy overhead costs of a traditional bank with all of its brick-and-mortar branches and ATMs.
Bankrate.com tracks and reports on the best rates for many of these online national accounts, which currently top out at 1.15 percent for high-yield savings, 2.5 percent for a five-year CD and 4 percent for a credit union checking account with a $10,000 cap.
"You have to play small-ball," Barrington said. "These are not get-rich-quick strategies. You have to look for every little edge that you can, because little edges are all that there are right now."
To go further, consider a high-quality U.S. Treasury bond, but only if you have at least $10,000 to invest. "That's really only efficient if you have a larger sum," Barrington said.
He also cautioned about investing directly in a bond, where you know what the yield will be if you hold it to maturity, versus a bond mutual fund, where the yield could be diminished by fees and trading activity.
Corporate bonds are another option, but they're much riskier since the companies issuing them can fail. And bonds also come with the risk that their value could drop if interest rates rise -- a very real possibility at some point with rates now so low.
On the other hand, even the historically safe U.S. bonds have proved to be risky, given the massive uncertainty recently over whether the federal government would default if Congress didn't raise the debt limit.
"This is just an incredibly challenging environment, at a time when not even U.S. Treasury bonds can be considered completely without risk," Barrington said. "They're still pretty safe to go, but there's a risk that we've never had to worry about before."
Even so, a little risk isn't bad, even for retirees, McBride said. He recommended allocating some money toward dividend-paying stocks, real estate investment trusts, high-quality corporate bonds and inflation-linked bonds that can generate income while still protecting a consumer's long-term buying power.
Stocks with regular quarterly cash dividends -- typically well-established firms and financial institutions -- provide investors with some certainty of a return on their investment. However, the price of the stock itself can still fluctuate or fall, and companies do occasionally cut dividends in hard times when they need to preserve cash.
Real estate investment trusts allow sophisticated investors to participate in real estate development and price appreciation, but can obviously be impacted by falling property values.
Inflation-linked bonds, or Treasury Inflation-Protected Securities, provide some protection against inflation. The principal value rises and falls with inflation or deflation as measured by the Consumer Price Index, and the bond pays interest twice a year at a fixed rate, based on the adjusted principal amount. The investor also receives the higher of the adjusted or original principal when the security matures.
Such investments can be worthwhile as long as investors understand the risk and limit it to what they are willing to bear.
"A 70-year-old could see their buying power cut in half over the next 25 years, at even a modest rate of inflation," he said. "Limiting yourself to strictly conservative cash investments won't compensate or won't address that loss of buying power. You don't want to go too conservative."