I recently received a letter from a Birmingham News reader signed, “A Frustrated Retiree”. In the letter he describes his frustration with the CD rates currently being offered by the banks and wants to know when rates will rise and what should he do with his money now in order to get more income.
There are no easy answers to his question. As he points out in his letter, the banks don’t seem to want your money. We recently contacted a local bank looking for their best interest rate on a $1 million deposit and the best offer we got was four-tenths of one percent. Much of the blame originates with the big banks that were at the forefront of the financial crisis that erupted in 2008. However, the current low interest rates we are experiencing have been orchestrated by the Federal Reserve lead by Chairman Ben Bernanke. The fed lowered short-term rates to near zero in an effort to stimulate our economy and encourage banks to lend money to businesses. In addition, congress gave the big banks $700 billion in stimulus money to shore up their balance sheets and encourage lending. The banks didn’t use the money to lend to businesses and businesses began storing up cash versus borrowing money to expand operations. Now the Federal Reserve is taking action (Operation ‘Twist’) to drive down longer-term interest rates as well. It’s working. The 10-year treasury is currently yielding about 2%. This is a deplorable situation for retirees who depend on investment income to help pay their bills.
To help Mr. Frustrated Retiree, I outline a range of investment options along with their relative income payouts and risks:
Low to No Risks
- Money market accounts. Money market accounts are generally paying less than two-tenths of one percent but by shopping you may find rates as high as approximately 1%. Visit www.BankRate.com.
- Bank CDs. A national search for the highest yields on CDs indicates that you can earn between 1% and 2% for investments of between one and five year duration. Again, visit www.BankRate.com for competitive rates.
- Treasury Bonds. One year treasuries are yielding one-tenth of one percent while the 10-year treasury is yielding about 2%. The 30-year treasury is yielding 3%. While there’s little to no credit risk with a treasury, as you lengthen the maturity, you take on interest rate risk. For example, if you invest $10,000 in a 30-year treasury and interest rates rise 1%, the value of your bond will drop nearly 20%. Of course if you hold your bond until maturity, you’ll get all your money back.
Low to Moderate Risks
- Investment grade bond funds. As long as you stick with investment grade most of your risks will be attributed to the average maturity of the bonds held by the fund. Excellent examples include Vanguard Short-Term Investment Grade fund yielding 2.8% with an average maturity of 3 years; Vanguard Intermediate-Term Investment Grade fund yielding 4.4% and an average maturity of 6.8 years; and Vanguard Long-Term Investment Grade yielding 5.28% and an average maturity of 24 years.
- Muni bond funds. If you are in a relatively high income tax bracket, you might consider muni bonds or muni bond funds, also for your foreign income providing valid cards, accounts (learn what to do if you lost the PAN card). Examples of high quality muni bond funds include Vanguard Limited Term Tax Free yielding 2.1% and an average maturity of 2.6 years; Vanguard Intermediate-Term Tax Free yielding 3.6% and an average maturity of 6 years; and Vanguard Long-Term Tax Free yielding 4.2% with an average maturity of 8.7%.
- GNMA funds. Ginnie-Mae funds invest in pools of home mortgages backed by the full faith and credit of the US government. Vanguard’s GNMA Fund is currently yielding 3.1% with an average maturity of 5.3 years.
As you can see from these examples, there’s not much opportunity to increase your income by investing in high quality fixed income investments and these yields are not likely to improve significantly for two to five years as Fed Chairman Bernanke has promised to keep rates low for a minimum of two years.
Next week I’ll review a number of options for increasing your income by investing in equity type securities.