Nothing For Money

With interest rates at record lows, savers suffer. For better returns, shun the safest options and take more risk.

By Peter Coy

Paul Hernandez describes himself as “one of those people who believe in standing on your own two feet.” At age 48 he lost a job as a contract programmer for Princess Cruise Lines, and he hasn’t been employed since. For a long time that was fine. His wife was earning a good salary; they lived frugally, childless and debt-free; and they earned a steady investment income from conservative assets such as bank certificates of deposit. Now things are getting tighter. As expected, his wife retired. Unexpectedly, their income from investments has plummeted because of falling interest rates. Hernandez, now 60, blames the Federal Reserve for hurting savers like himself by lowering rates in an effort to spur economic growth.

“I’ve sent e-mails to [Fed Chairman Ben] Bernanke. I know he doesn’t read them,” says Hernandez. “We were always believers in base hits, accumulating your money slowly. That’s all being ripped out from under us. In this bizarro world, the people who didn’t carry a lot of debt are paying for it all. And it seems like nobody cares.”

Hernandez has a point. Interest rates haven’t been this low in the U.S. in at least a century. A 10-year Treasury note yields just 1.7 percent a year, and a one-month Treasury bill has an annualized return averaging just 0.05 percent over the past year. That’s great for the world’s biggest borrower, the U.S. government, but it’s hell on savers. At that rate, an investor in one-month T-bills could double his or her money in — wait for it — 1,387 years. Since inflation is running at close to 2 percent, you’re actually losing wealth by putting your money into Treasury securities.

Moving your money abroad may not help, either. Fourteen countries, with a combined equity and debt market capitalization of $65 trillion, have near-zero short-term interest rates, says Bank of America Merrill Lynch Chief Investment Strategist Michael Hartnett.

Senior citizens suffer the most from low rates. People 75 and older get 8 percent of their income from interest, dividends, and rents, according to an analysis of government data by Diana Furchtgott-Roth, a senior fellow at the Manhattan Institute. People younger than 44 get less than 1 percent of their income from those sources.

What can savers do about this Fed-induced predicament besides complain? Hernandez’s choice is to stick with the safest, shortest-term securities — low yields be damned. That strategy may make sense if you’re going to take money out soon, or if you’re so risk-averse you sell in a panic whenever the market hiccups. Hernandez, who lives in Henderson, Nev., shies away from riskier assets because he thinks the Fed is manipulating markets. “I believe we’re sitting on a house of cards,” he says. “Every bit of our money is going into CDs and money markets now.”

For most people, though, being ultra-cautious won’t produce the growth needed to pay for the children’s college or a golden retirement. The Federal Reserve, by pinning short-term rates to the floor, is effectively pushing you to take some chances with your money. “Don’t fight the Fed,” says Larry Elkin, a certified financial planner and president of Palisades Hudson Financial Group in Scarsdale, N.Y. “You’re bringing a rock to a gunfight.”

If your goal is income, alternatives include dividend-paying stocks — the average yield for stocks in the Standard & Poor’s 500-stock index was 2.2 percent as of Dec. 12 — or real estate investment trusts, which invest in properties such as office buildings and also boast dividends. A Bloomberg REIT index had a 3.5 percent dividend yield as of Dec. 12. Mortgage-backed securities, emerging-market debt, and high-yield bonds have seen the biggest percentage gains in assets lately. Remember, spreading the money among asset classes will reduce the fluctuations in your portfolio.

In the fixed-income world, corporate and municipal bonds offer better yields than Treasuries. The FINRA-Bloomberg Active Investment Grade U.S. Corporate Bond Index yielded 3.4 percent on Dec. 12, 2.7 percentage points above the benchmark five-year Treasury note. You can also get some juice from munis, although not as much as usual: Their yields are at 47-year lows — 3.3 percent as of Dec. 12, according to the Bond Buyer’s average for 20-year Aa2-rated general obligation bonds. If you do buy bonds, consider shorter maturities. They’ll lose less value if interest rates rise. Plus, as they mature you’ll have cash to pour into higher-yielding securities. Like it or not, this is not the time to make a living from clipping coupons.

The Fed has not suppressed interest rates this much for this long since 1942 to 1951. Under the control of the U.S. Department of the Treasury during that period, the Fed was ordered to make it easy for the government to borrow cheaply to pay off debt incurred in the war effort. Back then it kept long-term Treasury bonds at no more than 2.5 percent and short-term Treasury bills at no more than 0.375 percent, according to George Mason University economist Lawrence White.

Rates are even lower today. Bernanke knows he’s not popular with people trying to live off interest income. He’s heard the talk of “financial repression” and “the war on savers.” But he continues to argue that Zirp — zero-interest-rate policy — is the right medicine for the economy. And he’s taking his argument to the public.

Bernanke made his case on Oct. 1 in an address to 2,000 business leaders and investment advisers at a luncheon of the Economic Club of Indiana. Two weeks before, the Fed’s rate-setting committee announced it would buy $85 billion of bonds per month for as long as necessary “if the outlook for the labor market does not improve substantially.” Wall Street wags immediately dubbed the open-ended commitment to quantitative easing “QE infinity.”

Bernanke acknowledged to the Indianapolis audience that low rates on savings “involved significant hardship for some,” while pointing out that “savers often wear many economic hats.” Low rates might hurt you as a saver but help you as a homeowner, business owner, stock investor, or jobholder. If the Fed pushed up interest rates prematurely, Bernanke said, “house prices might resume declines, the values of businesses large and small would drop, and, critically, unemployment would likely start to rise again.” He concluded: “Such outcomes would ultimately not be good for savers or anyone else.”

The audience was polite, not wowed. “He gave a vigorous defense,” says George Farra, a registered investment adviser and principal of Woodley Farra Manion Portfolio Management in Indianapolis who’s also treasurer of the Economic Club of Indiana. “I’m not sure it was convincing about zero percent for savers, but he went at it, that’s for sure.”

Many investors have resisted the Fed’s prodding to take more risk — and suffered as a result. Money flooded into low- or zero-yielding bank accounts last year after the Dodd-Frank act granted temporary unlimited FDIC insurance on bank deposits. (One question: How much money will leave the banks, and where will it go after Jan. 1, when $1.4 trillion in deposits above the $250,000 threshold become uninsured?) Since the stock market’s 2009 bottom, stock funds have captured only 11 percent of the inflows into open-ended U.S.-based mutual funds and exchange-traded funds, with the other 89 percent going into bond mutual funds and ETFs, according to Morningstar data.

That means many investors have missed out on a huge bull market in equities. From its scary low on March 9, 2009, through Dec. 12, 2012, the S&P 500 doubled in value. Over that same period, the J.P. Morgan U.S. Aggregate Bond Index returned just 28 percent.

Why are investors still seeking shelter in something that offers no significant shelter? Wishful thinking plays a part. “One of the things that we hear out of clients is, ‘Just give me a safe, high-yielding investment.’ We tell them, ‘That doesn’t exist,’ ” says William Allen, vice president for portfolio consulting at Schwab Private Client Investment Advisory. “If you want pure safety you have to give up some yield, mostly all yield. We spend an awful lot of time trying to level-set investors” — that is, lower their expectations.

There’s also some anecdotal evidence that the Fed, far from enticing investors to take more risk, is inadvertently scaring them off. “Investors Not Acting in Their Own Best Interest” was the headline on a press release from State Street, the big institutional bank. “Most retail investors believe preparing for retirement requires aggressive investing, yet 31 percent of their assets are in cash,” State Street’s Center for Applied Research think tank found in a survey. The Fed’s bold actions do not seem to have reassured investors. Rather, said State Street, “growing awareness of the financial system’s instability” is leading investors to seek safety at the expense of yield.

Savers and investors can’t change this state of affairs. What they can do is take advantage of it. Because your assets aren’t earning much, at least be sure that your liabilities aren’t costing much. Extinguish high-cost debt using cash or lower-cost debt, such as by using a home-equity line of credit to pay off credit cards or auto loans.

Remember, though: Some debt is good to have. If you have headroom on your home-equity line of credit and you think you might need a lot of cash in the next couple of years, pull out the cash now so there’s no risk the bank will freeze the home-equity line, advises Elkin of Palisades Hudson.

Extremophiles are tiny creatures that live in some of the world’s harshest environments, like volcanic vents at the bottom of the ocean. For savers, today’s zero-rate world is the harshest of environments. The trick is to adapt to the circumstances and become a financial extremophile.


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