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En español | Hal and Sylvia Rawley are about to take a 75 percent hit on their retirement investment earnings. And, no, the Pearland, Texas, couple didn’t gamble on some risky stock fund or get suckered into a Ponzi scheme.
They put their money in the bank.
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Specifically, between 2008 and early 2009 the Rawleys invested most of their savings in long-term certificates of deposit, or CDs.
Like generations of prudent retirees before them, the Rawleys believed their CDs would provide decent interest income, and, indeed, the couple earned as much as 4.5 percent interest. But now, as these CDs mature, the Rawleys would be hard-pressed to earn more than 1 to 2 percent if they reinvest in new long-term CDs.
Instead, they chose to warehouse their savings in a credit union savings account earning 1.1 percent.
“This country was built on hard work and savings but is now really screwing over savers,” says Hal, 78, who served in the Air Force for 23 years before working for more than three decades in the private sector.
The Rawleys — and millions of other older Americans seeking safe income — have become collateral damage in the Federal Reserve’s strategy to rescue our moribund economy. More than three years ago, the Federal Reserve stepped in to buoy the cratering financial sector and protect the economy from a Depression-magnitude backslide.
One of the Fed’s key tools is the federal funds rate, the rate banks pay to borrow money. Lower this rate and down go interest rates on CDs, money market accounts and other short-term investments. At the end of 2008 it effectively hit zero. It hasn’t budged since.
The idea is that if borrowing is cheap — low rates on savings also mean low rates for loans — businesses and regular folk will borrow money that they will reinvest in the economy. The policy is also meant to drive people into the stock market in search of higher returns, boosting prices there and helping investors and businesses.
Is it working? Well, the country did avoid a catastrophic depression and has so far skirted a second recession, but we have yet to see the economy grow with much vigor.
With Federal Reserve chairman Ben Bernanke’s pronouncement that short-term interest rates will stay low through at least mid-2013, we’re looking at a near-five-year stretch of a zero-interest-rate policy. That means for five years running you won’t earn anything meaningful on safe bank deposits such as CDs, and what you do earn won’t keep pace with inflation (recently edging close to 4 percent ).
Tricky times indeed. But you can survive the war on savers.
With CDs and high-yield savings accounts paying out measly income these days, banks are happy to suggest alternatives that earn more, including bond funds and dividend-paying stock funds. But just because you’re investing at your friendly bank doesn’t mean your investment is guaranteed.
Only bank deposits — CDs and savings, checking, and money market deposit accounts — are federally insured. The very nature of those short-term investments is that you’re guaranteed to get back what you put in, plus interest.
Step 1: Avoid Fees, and Seek Better Yields
If your bank is paying you zilch, consider a credit union. Because of credit unions’ nonprofit structure, they typically offer better interest rates on their accounts. Do some research comparing credit unions online at DepositAccounts.com.
“With some elbow grease you can earn a percentage point or two on your cash,” says Greg McBride, senior financial analyst at Bankrate.com.
Plus, 78 percent of credit unions surveyed don’t charge a monthly fee for checking, Bankrate.com reports — compared with just 45 percent of banks.
You can search for local credit unions at aSmarterChoice.org or ask friends and family if they belong to one: Often all you need to join is a connection to a current member.
Once you find a credit union, Ken Tumin of DepositAccounts.com suggests a two-pronged strategy: Use the credit union for your basic checking needs, then shop online for the best returns on your savings. That might be a bank or a credit union.
And if you have a 401(k), see if a stable-value fund is part of the mix. These funds are a breed of lower-risk investment, akin to money market mutual funds, but with higher yields, and available only through retirement accounts such as 401(k)s.
Step 2. In Bonds, Go for Short Term and High Quality
Yields on shorter-term Treasury bonds and high-quality corporate bonds are about as low as Congress’s approval rating. So it’s tempting to move some of your money into higher-yielding pockets of the bond world, be they longer-term or lower-quality corporate bonds.
“But there is always a trade-off,” notes Laura Thurow, codirector of private-wealth-management research at Robert W. Baird & Co. “It’s so important to understand what risk you are taking on when you invest in something with a higher yield.”
And this is no place to take outsize chances. “Keep reminding yourself what the purpose of your bond portfolio is,” says Christine Benz, director of personal finance at Morningstar. “It’s not the return engine of your portfolio. It’s for stability.”
That’s an argument for keeping the majority of your bonds in high-quality issues with a duration of five years or less. Remember: Bond prices decline when interest rates rise, and this price volatility increases in bonds with a longer time to maturity.
If you want higher yields, limit your appetite for investments such as junk bonds — the debt of corporations whose balance sheets are deemed to be of lower quality — to no more than 10 to 20 percent of your overall bond portfolio. You may earn 7 percent, but you’re taking the risk that the company paying the interest may default on its payments.
Just don’t overindulge: Think of this kind of investment as dessert, not the main course.
Step 3. Use Dividend-Paying Stocks to Whip Inflation
Consider this: If inflation averages just a moderate 3.5 percent over the next 15 years, it will take more than $1.60 to pay for the same things that $1 buys today. To pay your future bills, think about having a stock portfolio that can keep pace with inflation.
Bud Hebeler of the Analyze Now website follows a simple age-based formula for calculating how much: 100 minus your age for the minimum percentage of stocks, with a maximum of 10 percent over that. At age 78, he’s currently on the low end of that range, with about 23 percent of his money in stocks.
Next: Find out more about how to focus your stock portfolio. >>
Cash and bonds provide stability, whereas stocks offer the potential for inflation-beating gains over the long term. One trick is to make your stock portfolio pull double duty and give you an income stream today, by building it around stocks that pay dividends — income payouts that corporations make to shareholders.
Let’s say a company’s stock sells for $25 a share and pays an annual dividend of $1. That means for every share you buy at $25 you will get an annual income payout equal to 4 percent. If you already own a broad stock market index in your 401(k), you are getting some dividend income; the yield on the S&P 500 is about 2 percent these days.
You can get more dividend income by focusing on a portfolio that specializes in dividend payers.
All of this should offer some pretty good ammunition for savers who are ready to fight back.
Carla Fried has written for Money and The New York Times.
You may also like: The pros and cons of credit unions.
Focusing your stock portfolio on companies that pay dividends can be a smart move. You can collect dividends and use them for current living expenses, or reinvest them in more shares, thereby enhancing the total return of your investment. But it’s important to understand that deriving income from stocks is quite different than from bonds.
Stock dividends aren’t guaranteed. Companies can stop paying or reduce the amount if they hit tough times.
Case in point: In 2009 more than 800 companies cut payouts by a cumulative $58 billion, with much of the carnage coming from banks. A U.S. Treasury bond, in comparison, never cuts its payout.
Your workaround: Opt for mutual funds and Exchange-Traded Funds that own a broad diversified portfolio of dividend payers from different segments of the economy. For example, the Vanguard 500 Index Fund (VFINX; dividend yield: 2.03 percent) invests in the stocks of 500 companies, and the SPDR Dividend ETF (SDY; dividend yield: 3.2 percent) currently invests in 60 stocks. That’s far safer than owning just a handful of stocks.
Dividend payers aren’t bear-proof. A 3 to 5 percent dividend payout won’t eliminate the pain of a bear market but can soften it. In 2008, for example, companies in the S&P 500 stock index that paid a dividend lost 39 percent of their value. But nondividend payers did even worse: They lost 45 percent.
Your workaround: Remember that stocks are stocks and bonds are bonds. You should have an age-appropriate mix of both, and then stick with the plan, no matter what the market or the economy is doing. Even solid dividend payers can slump, so you never want to sell bonds to load up on dividend stocks.