Finding Attractive Interest Rates in a Low-Yield Environment

How to Make Money When Interest Rates Are Low

Interest rates across the board remain low, and this wasn’t helped by the fact that the Fed recently lowered the target rate to it’s lowest point ever. This means that most deposit accounts will continue to cut back on yields, and this is bad news for savers. And if that wasn’t bad enough, you actually have short-term treasuries in some cases offering a 0% yield.

Most people don’t use savings accounts and CDs to make a lot of money, so the percentage point or two that yields have dropped won’t wipe out your wealth building plan. Instead, it’s inflation that you need to worry about. If your money is only earning 2% while inflation is at 3%, even though your account is making money, when you factor in inflation, you’re actually losing money. And if you factor in taxes, you’re in even worse shape.

This isn’t a situation you want to be in, where you’re putting money away that’s intended to be a safety net, yet your purchasing power is slowly being eroded by inflation. This is why even a 1% difference in yield can be important over the long run. Sure, it might not seem like a big deal if you’re talking about $100 a year, but the more money you have saved, and the longer it sits there, it can compound and start to weigh on your total returns.

So, with rates suffering lately, where you can turn to lock in a good rate? Luckily, there are a few places that you can go to find an attractive interest rate.

Savings Accounts

The first, and most obvious place to turn is the bank. Savings accounts are easy to set up, most should be FDIC insured, and they are completely liquid. The availability and liquidity of these accounts are what make them so attractive. Whether it’s through your local bank or credit union branch, or via an online bank, you can generally set up an account in a matter of minutes. And when you need the money, it’s usually as simple as a phone call, ATM transaction, or online request.

That’s the good news. The bad news is that savings account rates react fairly quickly to rate cuts. This means as rates go down, your savings account rates are likely to follow. In some cases, banks will cut their rates almost immediately after an announcement, while others may keep their rates steady for a while before making a change. This is where it can get confusing, as you will find a great discrepancy in rates among different banks. Your local bank might only offer 1%, while one online bank is offering 3%. Then, another online bank might only be offering 2.5%. Because of this, it can be easy to fall into a rate chasing trap. Some people spend more time moving their money around than anything else, and that isn’t an effective use of time. So, the key is to find an online bank that provides a good rate while not being so quick to change rates when other banks do.

You can check with your local bank or credit union to see what kind of rates are available, but in most cases they are going to be less than what you could get at an online bank. But, if you have a good relationship with your bank, it’s at least worth checking into first. If you’re looking for an online option I’d recommend FNBO Direct for the best rates and service.

Certificates of Deposit

If immediate liquidity isn’t as much of a concern, one of the best places for cash right now is in CDs. CDs are actually great in a falling rate environment since you get to lock in a set rate for a specific amount of time. That means if you pick up a 1-year CD paying 4% and rates continue to fall elsewhere, you’re still getting your 4% for the full year. Of course, the opposite is true when rates begin to rise, and you could lock yourself into a lower rate than what can be had elsewhere.

In addition, these are time deposits, so you need to keep your money invested for the amount of time agreed upon. Granted, you can get out of a CD early, but you’re going to typically pay a penalty that wipes out most of the benefit of the interest rate. So when it comes to CDs, you have to be a little more careful and plan according to your needs for the money. If it isn’t money you’d need at the drop of a hat for something like an emergency car repair, tucking money into a CD is not a bad idea. And don’t forget about the various term lengths. You can get a CD with a short term of just a few months, all the way to 5 years or more. And it’s all risk and reward from there. Short-term CDs will have a lower rate, but you’re at less risk of missing out on money because of a interest rate increase. But at the same time, long-term CDs will pay more, but you’re putting yourself in a position where you may miss out on higher rates at some point in the future or need to take a penalty for an early withdrawal.

Another thing to consider is the minimum to open a CD. In many cases, you need to have a few hundred to a few thousand dollars. Granted, there are a few no minimum CDs out there, but usually your rate will suffer. Also, don’t forget to check your local bank or credit union. While there are plenty of online options, local banks are notorious for offering CD specials or bonus rates for new deposits. And in many cases, banks have the ability to negotiate rates to a certain degree. If you’re a long time customer that does a reasonable amount of business there, it doesn’t hurt to ask to see if there is anything else they can do for you. Banks want these deposits, so use that to your advantage when shopping around. Right now, CD rates are anywhere from around 2.5% – 4% for a 12-month term.

Money Market Mutual Funds

Earlier this year we all heard about the Reserve Fund that “broke the buck.” Money market funds are supposed to be as safe as cash, but this fund got caught up in the whole mortgage crisis and it suffered as a result. This caused a lot of panic in the money market arena, but most of it was unwarranted. Since the Reserve Fund incident, there has been little concern with other funds.

The real benefit with money market mutual funds comes in the fact that these are available to virtually anyone with a brokerage account. No need to create a new account, give out your personal information again, or link to another bank account. You can put money into one of these funds just like you would any other mutual fund. Liquidity is generally subject to the stock market hours of operation, but otherwise if you’ve linked up your bank account to a brokerage account, transferring money is a snap. Another overlooked benefit is that there are also many tax-free money market funds. So, not only can you earn a little interest, but you can keep some extra money out of Uncle Sam’s pocket. To determine your real rate of return on a tax-free fund, calculate your tax-equivalent yield.

One drawback of many of these funds is that they usually invest heavily in treasury securities, and when they are earning next to nothing, it really drags on the yield. Also, the yields on these accounts are constantly changing. The yield may fluctuate almost daily. This isn’t a bad thing as rates begin to increase, but when rates are still falling, it isn’t ideal. But, if you want to keep this money on hand and ready to invest in your brokerage account, they do that very well. If you’re looking for a free brokerage account, I’d take a look at Zecco.

Here is a list of some of the more popular money market funds and their rates as of 12/22/08:

Credit Cards

You’re probably scratching your head at this one. How on Earth can you make money with credit cards? What a stupid idea! Well, I’m not talking about using credit cards to rack up cash back or bonus points or anything. Instead, I’m referring to paying off high-interest debt. If you have an outstanding balance racking up a 15% interest rate, paying extra on this debt can be far more beneficial than the few percentage points you’d make in a savings account or CD.

Of course, the drawback is that you don’t actually have cash being put aside. So, this method isn’t for someone with absolutely no cash cushion or emergency fund. You still need to make sure you have an emergency fund established, but once you are comfortable with your savings, instead of tucking more money away in an account earning 3%, consider diverting some funds to higher interest debt. Whether it’s credit cards, an auto  loan, or even a mortgage with a higher interest rate. You won’t see the immediate benefit in your bank account, but you’ll be positioning yourself to pay off that debt sooner, likely saving thousands more than you would have earned in a savings account.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.