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In a low-rate world, here's how savers can help themselves

November 21, 2009|Tom Petruno | Market Beat

You'd think that $10 trillion would merit a little more respect.

That's the total now sitting in bank savings accounts, savings certificates and money market mutual funds.

And it's earning an extraordinarily tiny return for the American consumers and businesses whose names are on the accounts.

The average yield on a six-month CD is about 0.9%, down from 2.2% a year ago, according to Informa Research Services. The average money market fund pays an abysmal 0.04% annualized yield.

We all know how we got here: The financial system crashed, taking the economy with it, causing the Federal Reserve to push short-term interest rates to near zero in the hope of avoiding Great Depression II.

The question that every bank saver would dearly love answered: How soon might short-term rates rise enough to at least lessen the feeling that you're having your pocket picked by a grand conspiracy of the Fed, the Treasury and the banks?

Just a month or so ago, with the U.S. economy showing more signs of revival, Wall Street futures traders who bet on interest rate trends were ascribing a 68% probability that the Fed would be raising rates at its June 2010 meeting.

Whoops -- not so fast. Disappointing economic data in the last few weeks, and cautious public comments from some Fed officials, now have futures traders reconsidering when that first rate hike might come. The probability of a boost at the Fed's June meeting has plunged to 28%.

This week, the head of the Fed's St. Louis branch, James Bullard, caused a stir when he suggested that the central bank might wait until 2012 to begin lifting rates.

Bullard didn't say that the Fed would wait that long, but he noted that after the last two recessions (1990-91 and 2001) it took 2 1/2 to three years before policymakers began to tighten credit. If the recession that began in 2008 ended last summer, the timetable of the last two downturns would leave the Fed on hold until the first half of 2012.

It's difficult to imagine short-term interest rates at these levels for another 2 1/2 years. But then, it's also still difficult to fathom what has happened to the financial system and the economy over the last 18 months.

Everybody understands the need for low interest rates to repair the banking system and ease the massive debt load burdening American consumers. And as for the argument that savers in short-term accounts don't deserve much of a return because they're taking no risk -- yeah, they get it.

But the ironies of this rock-bottom-rate regime are glaring. It has taken the worst recession in a generation or more to make huge numbers of people understand that they need to save more. Now that they're trying to do so, they can't earn a decent return.

The not-so-subtle message from the Fed is, "If you want a higher return, you'll have to take more risk" -- in the stock market, for example. But many people aren't in a position to take any risk at all with their savings, particularly given the lack of job security.

Reaching for a better yield on their money, many savers are turning to government, corporate or municipal bonds. There is less risk in most bonds than in stocks, but it's still possible to lose principal in bonds, a fact that may not be readily apparent to newbie investors.

For whatever portion of your nest egg must remain absolutely protected from loss, you don't have any real choice but to stay in a short-term account. But unless you feel strongly about subsidizing your bank or mutual fund company, you can at least try to find the best-paying options for your cash -- especially given the possibility that this rate environment could persist for years.

Here are a few strategies to consider:

* Rethink the merits of money market mutual funds. Cash has been pouring out of money funds this year, and for good reason: Money funds can pay out only what they earn on the short-term government and corporate IOUs they own. So investors know there is no hope of fund yields' rising again until the Fed begins to lift its benchmark short rate.

The best alternatives to money funds are money market deposit accounts at banks, says Greg McBride, senior analyst at Bankrate.com. On that website and other rate-search services you can find federally insured accounts paying as much as 1.7% annualized. It's true that banks can change what they pay on these accounts at any time. And you also have to be OK with rules governing the number of withdrawals you can make.

But if you've got a sizable sum sitting in a money fund, you can do a lot better at banks.

* If you use certificates of deposit, build a ladder. Because predicting interest rates is a crapshoot, many financial advisors opt to use a laddering strategy with CDs, splitting clients' cash among certificates maturing every three months over the course of a year or two. If rates begin to rise, as maturing CDs come due they can be reinvested at higher rates.

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