Today’s low interest rates are a double-edged sword. For borrowers the low rates are great. The interest rates to refinance or purchase a home have never been lower. But if you are a saver, the interest you can earn is downright maddening.
And it’s a problem I’ve been really focused on as of late. My wife and I have some cash to save, but I can’t bring myself to put it into a bank account that pays next to nothing. So I’ve been doing a lot of research on alternatives to traditional bank accounts. Here are some options I’ve found that may prove helpful to you as you seek higher yields.
1. Online Banks: If you crave the security of an FDIC-insured account, there’s no question that online banks pay the best rates. We do keep some money in an online account (ING Direct) that pays about 0.80%. You can do even better today with CIT Bank, which currently pays 1.05% APR. If I were opening a new account today, CIT would be my first choice.
2. Bond Funds: I’ve put a lot of our cash in Vanguard bond funds. With this option, it’s important to recognize that you can lose money. Bond funds are not FDIC insured, but if you are investing in U.S. Treasury bonds, they are very safe when it comes to risk of default (if the U.S. ever defaults on its bonds, we’ll have a lot bigger problems than the value of our bond funds). But if interest rates rise, the value of the fund will go down.
For that reason, I tend to invest in short-term bond funds. The shorter the term, the less I’ll lose if rates go higher. Of course, it also means I won’t make as much if rates go down. As an example, Vanguard’s long-term Treasury fund (VUSTX) is up more than 31% in the last year. In contrast, its short-term Treasury fund that I invest in (VBIRX) is up only 2.12% in the last year. I’m not suggesting you go long, but there is a risk/reward to consider. The bigger point is that conservative bond funds do offer better yields than a bank account if you are willing to accept some risk.
3. Muni Funds: While also a type of bond fund, I put municipal bond funds in a separate category. Munis present a great risk of default as compared to U.S. bonds. But they can be tax exempt and offer higher yields. I invest in Vanguard’s High-Yield Tax-Exempt muni fund (VWALX) as an alternative to a bank account. This is a particularly attractive option for taxable accounts, particularly if you are in one of the higher tax brackets.
4. Dividend Paying Stocks: Here’s where even more risk comes into play, but also a much great chance of gain. Over the past two years I’ve started investing in blue chip dividend paying stocks. My investments have included the likes of McDonald’s, Verizon, Pepsi, and Apple (Apple didn’t pay dividends when I bought it, but it will soon). This is definitely not an option if you may need your cash soon. But I’ve found it to be an excellent alternative and a good way to further diversify my investments. If you want to see a list of dividend-paying stocks, check out this article Jonathan just published on My Money Blog. It’s an excellent resource.
5. Paying Down Debt: If you have high interest credit card debt, it’s a no-brainer that you start paying it down as quickly as possible. In our case, the only debt we have is our home mortgage (we tackled our credit card debt a few years ago). Even though our mortgage rate is below 4%, I’ve decided that paying down the mortgage ahead of schedule is a good use of some of our cash.
And that brings me to a very important consideration. You can use a combination of the above options. This is not all or nothing. We use some money to pay down our mortgage. We save some in an online bank account. And we invest some in various bond funds and dividend paying stocks. The result is a well diversified cash management portfolio. Is it riskier than keeping all of our cash in the bank? Yes, but the potential payoff seems to me to be well worth the risk.
If you put your cash somewhere not listed above, leave a comment and let us know how you manage your money.
Published or updated February 12, 2013.