How to get the best rates on your savings — safely

Over the past year, one of the frequent questions I get is: “Where I can safely invest my money to get a decent return?” For example, Joseph wrote in November:

Around February/March, I should have $5,000 to invest. My debts are under control and my wife and I have lowered our monthly expenses. I was wondering if you had any advice on ways to invest $5,000. I don't want a savings account because the interest rates are just sad, but I don't know if a certificate of deposit or money market account is worth the effort.

Or take this e-mail I got from MG just last week:

How about addressing how to invest $5,000, $10,000, or $15,000 these days? With high-yield savings rates getting lower and lower and the stock market not doing so well either, what would you recommend?

Note: Before I launch into the main point of this article, let me counter that last claim in MG's e-mail: The stock market hasn't been doing so well lately. What? In the U.S., the S&P 500 index is up over 30 percent in the past year. It's up nearly 60 percent since bottoming out on 06 March 2009. If that's “not doing so well,” I'm not sure what more MG wants! For long-term investing (as in decades), I am still convinced the stock market makes the most sense.

Because the stock market has been so volatile over the past 15 years, a lot of people are scared to invest. Or they just want to find safe places to put part of their money in the short term. Unfortunately, it's not like new ways to invest safely are being invented. If you want your money to be safe, you've basically got the same tried-and-true investments you are already familiar with.

Two recent articles in national magazines addressed this subject. Let's look at their advice.

Advice from “Consumer Reports”

The March 2010 issue of “Consumer Reports” has a great article on finding the best rates on your savings. They start at the same place we all start: bank accounts. Here is what “Consumer Reports” recommends:

  • Compare bank yields. They recommend checking out rates at Colorado Federal Savings Bank, Capital One Direct, and Axos Bank, as well as old stand-bys like Ally Bank and FNBO Direct. But remember: Sometimes the best place to earn money on your savings is in a checking account. You can use CheckingFinder to track down deals on rewards checking accounts around the country.
  • Be cautious about bonds. Bonds continue to be one of my blind spots, though I'm learning more about them as time goes on. The “Consumer Reports” article cautions against bonds right now because their long-term outlook isn't very good. If you are interested in bonds, consider Treasury Inflation-Protected Securities (TIPS) which give a modest return but offer built-in protection against inflation. (I've got a small post for later today that looks at I Bonds, which also protect against inflation.)
  • Look at stock dividends. Some stocks pay regular dividends to shareholders, dishing out five or six percent a year. That's probably way more than your bank pays on savings, but it also exposes you to added risk. You can reduce this risk by diversifying: Buy a mutual fund with high dividends instead of individual stocks. Examples include XLU (a utilities sector exchange-traded fund with a 4.31% yield), TWEIX (American Century Equity Income fund, yielding 2.77%), VEIPX (Vanguard Equity Income fund, yielding 3.14%), and VWNFX (Vanguard Windsor II fund, yielding 2.33%).

To be honest, I am not sure that chasing stock dividends is the best way to get safe savings. Yes, I believe the market will increase over the long term; but folks who want safe harbors are usually looking to avoid risk — and, over the short term, stock funds are risky, even if they do have nice dividends.

The article suggests another option, one that I happen to like a lot. Because yields are so low right now, it can make sense to use your money to pay down your mortgage instead. You shouldn't do this if you don't have emergency savings yet; but if you are near retirement or still paying private mortgage insurance, this can be an especially great use of your savings dollars.

Advice from “Kiplinger's”

The March 2010 issue of “Kiplinger's Personal Finance” has a small section on finding better rates. Their advice? “Start by looking online. Ally Bank is paying 1.45% on savings — way north of the 0.23% average rate on money-market funds.”

“Kiplinger's” recommends taking on a little more risk in order to get better rates. In particular, the magazine suggests:

  • Vanguard Short-Term Investment-Grade Bond Fund (VFSTX), which has a 3.78% yield as of the end of January. (This fund has a $3,000 minimum investment.)
  • Fidelity Intermediate Municipal Income Fund (FLTMX), which has a 3.50% yield but offers tax advantages. (But there is a $10,000 minimum investment.)
  • Fidelity GNMA Fund (FGMNX, which owns home mortgages, currently has a 3.68% yield. (This fund has a $2,500 minimum investment; $500 for IRAs.)

For safe savings, bond funds may make more sense than stock funds, but I still think they are riskier than most people in this situation are after. I guess it depends on your goals.

The bottom line

As you prepare to save, you need to ask yourself a few questions:

  • What are your goals with this money? If you are saving for retirement, stashing money in a savings account probably isn't the best way to go about it. You are not going to get the returns you need. In fact, you'll barely keep up with inflation.
  • How much risk can you tolerate? Risk and return are intertwined. If you want high rates of return, you are not going to get them with safe investments. To do that, you have to be willing to tolerate ups and downs. If you are okay giving up potential gains in order to protect your money, then there are a variety of options.
  • How liquid do you need the money to be? That is, do you want easy access to the money? Some investments — like certificates of deposit and savings bonds — can offer higher rates of return — if you promise not to touch the money for months or years.

Where do you put money that you want to keep safe? Do you even worry about returns? How can GRS readers find a good balance between safety and earnings?

Note: A couple of weeks ago, “The New York Times” Bucks Blog ran a piece on the least-trusted banks in America. For those who get on my case for pimping ING Direct instead of HSBC Direct, check this out. HSBC is the least-trusted bank in the U.S.; ING Direct is the most-trusted bank in the country after credit unions (which were way ahead of the pack — way ahead) and USAA.

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