How To Save In A Low Interest Rate Environment
Let’s face it we won’t be seeing a 12% CD or a 5% savings account again, or at least in the near future. With companies no longer offering a pension and some even have done away with matching 401K contributions and even discontinuing the 401K completely, building a savings for yourself has become more important. The question is in a low interest rate environment as we are in today, how do we save and stay ahead of inflation?
Not only is the return on your savings important, we also need to take inflation into account. Inflation reduces your buying power, making your $1.00 buy less every year. So the challenge is increasing your buying power when inflation is lowering it. 1980 saw the highest inflation rate over 13.5% according to the Bureau of Labor Statistics with both 1979 and 1981 over 10%. The average inflation rate for those three years was 11.71% Putting that into perspective if you bought something for $1.00 in 1979 it cost about $1.41 at the end of 1981. A car purchased for $10,000 in 1979 was now selling for $14,000. For the past 10 years the inflation rate has averaged around 3.5% - 4%. In order to break even we have to grow our accounts by 3.5% - 4%. But how, have you seen the CD rates and savings rates?
Current CD rates are around 1% for a 12 month CD with a standard savings account paying .25%. High balance accounts like money markets, are paying about 1.5% - 2.0%. Some online only banks are offering higher amounts as long as you meet their requirements, which may just be having direct deposit and online bill pay. So how do we save and how do we know how much we need? Since we could go on forever if we tackled both problems, I am just going to go over how we can save.
There are many savings vehicles you can use ranging from bank savings to investment accounts. Which one is going to be the best one for you is determined by a couple of factors. First and foremost, when do you expect to use the money? Now I understand sometimes emergencies pop up and you may need the money sooner than expected, these times are rare, so don’t get caught up in that. Under normal circumstances when do you expect to use the money? If you need it in less than 6 months, your best bet is looking at a savings account. The amount will determine the interest rate, but lets face it, if need the money that soon, growth is really not major concern, it would be liquidity or easy it is to get the money. For example let’s say you have $10,000 and you need it in 3 months and the savings account is paying 1%, the current rate at my bank for this balance, the interest growth is $24.99. Don’t expect high rates, typically no higher than .5% in our current market.
From 6 months to a year either a CD or a Savings account would suffice depending interest rate and liquidity needs. If you do not need to use the funds for 1 – 5 years, you are probably better off in a CD, as they can be tailored to your needs, like a 23 month CD rather than a 24 month. Pretty much all banks and credit unions will have a CD special that you may be able to use. Also don’t be afraid ladder CD’s to come due at different times, depending on your needs. Currently CD’s are coming in at 1% - 3% depending on term.
For money that you do not expect to use before 5 years, I highly recommend talking with a Financial Professional. Now, I don’t mean your local banker down the street, I mean a professionally licensed Financial Investment Advisor. Your local banks have them too. Financial Representative are able to give you more options on what is going to best fit your needs. If you like having a lot of liquidity but want a higher return and are willing to take some risk, mutual funds may be the answer. Mutual funds come in various degrees of risk, so talking with a professional you can determine what is best for you. You may want tax deferral; Fixed and Variable Annuities may fit that bill. How about very low risk and a fixed interest rate, take a look at Municipal and Corporate Bonds. Any of these products can or have the ability to generate higher interest than long term CD’s. The best advice I can give for this group is seek out the advice of a Financial Professional.
Interest rates may never get very high again but knowing what you want your money to do or what it is for will help in finding you the best spot to put your money. Talk to a Financial Representative to make sure you know all your options. Within the past year, I have gotten clients not only CD’s but a 4.5% fixed annuity that increases its rate by .15% every year for 5 years. You may say it’s only .15%, I say it didn’t drop like CD’s and Savings rates. How long do you think it will take for CD’s and Savings accounts to get there? I also helped a client purchase a Municipal Bond at 6.25% bought at a discount so if he keeps it until it matures he will actually have received 8.5% over time. It all depends on your needs and purpose. Good Luck and I will see you in retirement.