How bank deposits are costing you and what to do about it
Thinking of saving a few bucks with your local bank? Forget it! The days of putting a little something aside in your “savings” account are long gone. That’s because these days, you’re earning just about nothing on savings account deposits. In some cases, you are actually earning nothing – often less than nothing – as the recent listed rate on deposit accounts at four reasonably large financial institutions was, yes, zero! Here’s what this means for you, and where you can put your money to actually save something.
My recent survey of deposit rates showed that while zero interest is not unusual, the highest rate is scarcely better, at 1.95%. So I did a basic calculation to see what this yield, assuming rates stayed this low for 30 years – very unlikely, of course, but it’s a dramatic illustration of just how insidious low returns can be to your financial health. Starting with $1,200, and contributing $200 per month, you’d wind up with a total of a little over $100,000 after 30 years. And only about $27,000 of that would be the interest you’ve earned.
Hand it over…
Factor in inflation, currently running about 2%, about 30% tax on the interest income, and of course the monthly fee the bank charges you just for keeping your money on deposit. In effect, your savings are purely theoretical, because you’re really paying to keep your money at the bank. In fact, you’re actually losing money – plenty of it – on every dollar you’re allegedly “saving.”
So where do you find decent yield in a low-yield world? It’s not easy. But with the right guidance, there are ways to invest your money, at a risk level that lets you sleep nights, with a decent return to boot. Here are some income-producing investments that financial advisors and portfolio managers consider when building an income portfolio for clients:
Bonds: better yield, some safety
Issued by governments and corporations, bonds pay interest at a fixed rate as specified by the bond issue. So a bond with a 4% coupon rate will pay out $40 per year for every $1,000 of face value. A bond’s actual yield, however, can be higher or lower than the coupon rate, to match prevailing market interest rates. That’s because once issued, bonds can be traded, and the price of a bond may be higher or lower than the face (or par) value at any given time. Retail investors won’t be able to buy or sell bonds themselves, but must work through a bond dealer, usually a bank or large brokerage firm. And minimum amounts are usually quite high, at least $50,000 or so.
Contrary to popular belief, bonds are not guaranteed investments. However, because they are a credit obligation of a government or corporation, they come first in the hierarchy of payment. There is default risk associated with bonds, but that risk is lower with government bonds and the best investment grade corporate issuers with high credit ratings, which is why these are often considered safer securities than, say, stocks. There’s also some market risk associated with bonds in that prices fluctuate.
Dividend-paying stocks for higher yields
Tried-and-true blue-chip stocks that have a long history of paying steady and increasing dividends are another powerful tool for investors seeking income. Dividend yields are typically higher than for bonds, which has made dividend stocks more attractive for investors in recent years. But dividends are not guaranteed, may not increase, or may be indeed be cancelled if the company falls on hard times. Preferred shares, with a fixed dividend payment rate, are often seen as a hybrid of a dividend-paying stock and a bond, coming ahead of regular dividends but behind bond payments.
Equities are subject to market risk, and prices fluctuate daily. While short-term risk may be higher, equities historically have better long-term growth potential than most any other asset class, including bonds. Dividend-paying stocks also tend to be less volatile than other stocks, and a regular dividend tends to support share price in down markets. This is why investment advisors allocate at least some portion of income portfolios to solid dividend-paying stocks.
Investment funds for diversification
As you’ve probably guessed by now, researching, selecting, and trading individual dividend-paying stocks and bonds is a time-consuming and costly business for most individual investors. That’s where investment funds, such as mutual funds and exchange-traded funds (ETFs) come in. Income-type funds are available in many different styles and combinations, including pure bond funds, dividend funds, or a mix of the two.
Funds provide diversification (thus lowering overall risk) by holding a variety of investments, and may be diversified geographically as well, holding assets from around the world or focusing on one region. The great flexibility and broad choice offered by investment funds make them a good choice for retail investors looking to diversify their income investments. However, it’s important to keep an eye on costs. Management expense ratios can vary widely, with MERs of mutual funds typically being much higher than those for ETFs.
Get the right advice
Speak to a financial advisor about the various income funds available that invest in a mixture of government and corporate bonds, and dividend-paying stocks. Your advisor should discuss your income needs, your objectives, and your tolerance for risk. They’ll then suggest the right mix of income investments to meet those needs. They’ll probably suggest opening up a Tax-Free Savings Account to hold those investments, so your return will be completely tax-free.
One thing’s for certain. Your savings will be real, rather than theoretical.
© 2014 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.