Americans are saving more since the economic downturn started in 2008. But interest rates are frustratingly low, and many economists expect them to stay that way until at least later this year. In the meantime, here's some advice on finding the best yields available now.
Online banks generally offer the best rates on savings and CDs. You can earn 1.5 percent to 1.7 percent on a savings account at Colorado Federal Savings Bank, Capital One Direct, Bank of Internet USA, Ally, and FNBO Direct, based on a recent search of Bankrate.com. Some online banks pay about 2 percent on a one-year CD.
You can get even better rates—as high as 4 percent—on high-yield checking accounts offered by some credit unions and small banks. But most require that you make 10 to 15 debit-card transactions per month, have your paycheck or Social Security check deposited directly, and manage your account online. Go to www.checkingfinder.com to find institutions offering those deals.
Check for fees before opening any account. Some online banks charge if you exceed a set number of transactions a month or if you access your funds through an ATM or teller. And stay in short-term savings so you're well positioned when rates rise. Avoid CDs with a maturity of more than one year, says Greg McBride, senior financial analyst at Bankrate.com.
In the current rate climate, steer clear of long-term Treasury bonds. Bonds could do well in 2010 if deflation reigns, but their long-term outlook isn't great. When rates climb bond values drop, and their yields will trail inflation.
Treasury Inflation-Protected Securities, or TIPS, are a better bet. TIPS offer the same safety as other Treasury securities and a potential upside if inflation heats up. TIPS track inflation—their value goes up with inflation and down with deflation. You can buy individual TIPS at TreasuryDirect.gov, but you might be better off investing in an exchange-traded fund such as iShares Barclays TIP or a mutual fund such as Vanguard Inflation-Protected Securities. Such funds make regular payments to investors and avoid some tax concerns that buyers of individual TIPS face. But if long-term deflation ensues, TIPS aren't the place to be.
I Savings Bonds also offer inflation protection, but they're a bad deal now. Their yield has two parts—a fixed rate and an inflation component, which is adjusted twice a year. As of last November, the fixed rate was a measly 0.30 percent.
Tax-exempt municipal bonds are attractive for people in high tax brackets, especially if income-tax rates go up. Build America Bonds, which are federally subsidized and issued by local governments, have been hot lately. They pay about 5 percent interest but are not tax-exempt.
If you prefer funds, you should probably avoid broad bond index funds because Treasuries make up a large part of their portfolios. Instead opt for a well-managed diversified fund such as Harbor Bond or a muni-bond fund from Fidelity or Vanguard. But keep in mind that if inflation picks up, noninflation-protected bonds aren't likely to flourish.
Stocks currently offer some enticing yields with more long-term upside potential than bonds. But there's also the risk that prices can fall or dividends can be cut. Even bond guru Bill Gross of PIMCO, an investment management company, prefers utility and telecom stocks over bonds. "Pricewise, they're only halfway between their 2007 peaks and 2008 lows," he says, "and most importantly they yield 5 to 6 percent, not 0.01 percent."
One strategy is to buy an exchange-traded fund that holds a basket of utility stocks, such as Utilities Select Sector SPDR. It pays 4.2 percent with annual expenses of 0.21 percent. Or you can buy an equity-income fund, which focuses on dividend-paying stocks and can pay 3 to 3.5 percent. American Century Equity Income, Vanguard Windsor II, and Vanguard Equity Income have been solid performers.
Here's a different way to boost your returns. With yields so low, consider paying down your mortgage instead of chasing interest rates, says Christine Benz, director of personal finance at Morningstar.com. This is especially advisable if you pay private mortgage insurance, are close to retirement, or don't have much of a mortgage-interest deduction. You will cut the total interest and the term on your mortgage. Of course, that option makes sense only if you already have an emergency fund sufficient to cover your household expenses for the next year or two.