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Squeeze More Yield Without Breaking the Bank

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar.

More than two years into the recovery, interest rates are still stubbornly low. So, is there any safe way to get a little bit of extra yield?

Here with me to offer some tips is Morningstar's Christine Benz, director of personal finance.

Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: So the Federal Reserve Chairman Ben Bernanke basically said recently that he's probably not going to be thinking about raising rates anytime soon. So that's bad news for a lot of people who have money in savings accounts or lower-yielding investments. It means they are not going to get lot of money for a while. A lot of people are thinking about where can I get some of that extra yield? But before we get into that, I just want to get a sense of how bad is the low-yield environment? Have we seen improvement in interest rates anywhere?

Benz: It's really bad, Jason. So, just an example, the typical CD, one-year CD product out there right now has a yield in the neighborhood of 1.2%, 1.3% if you are very lucky. A lot of money market funds, even very good low-cost money market funds like those at Vanguard, are barely eking into the black in terms of their most recently available yield figure.

So it's a tough environment, particularly given that we're always telling people who are in retirement that they need to have this one- or two-year sleeve of cash set aside. It's really tough for those folks because this is dead money or worse, given that inflation is possibly taking a bite out of that return.

Stipp: We certainly saw inflation start to heat up this spring. I think it's abated a little bit, but that 1% is not going to get you very far when you're seeing annualized inflation in the 2% to 3% range.

Benz: Right, exactly.

Stipp: So, there are a lot of people who are seeking yield, they are looking for yield; they are looking at some other alternatives to get a little bit of extra money out of some of their safer assets.

Well, there are safer ways to do this and less safe ways to do this. What are some of the safer ways if I am trying to get a little bit of extra yield to try to eke that out? What can I do?

Benz: Well in general CDs rather than managed products like money market accounts and money market funds will give you a little bit higher yield and the reason is that you are giving up some liquidity. So typically you have to sign on for a six-month or one-year CD, and you'll pay a withdrawal penalty if you need to get out early.

One product--and I give kudos to Ross Levin, the financial planner who was at our conference last week--he was talking about Ally Bank's five-year CD. People might say well, I don't want to tie my money up for five years, but Ally Bank's product offers something like a 2.4% yield currently and just a two-month penalty if you need to get your money out early. So that is kind of a neat product to consider without heavy strictures to pull down a little bit of extra yield.

Another idea, Ally Bank also has what's called "Raise Your Rate" CD. This is a two-year product. I think the yield is in the neighborhood of 1.4%, 1.5% currently. Not a great yield, but the advantage is if you see the yields rise on two-year CDs during the life of your holding, you are actually able to obtain that one-time higher yield. So you get a bump up in your yield. That's a nice product to consider.

Stipp: So we're seeing there are a lot of different institutions that offer CDs. What's a good way to comparison shop? Should you go out and look across the neighborhood or how much shopping should you do here?

Benz: Well, I think it's an important reminder that going nationally or casting a wider net can be a really good thing to do when you are shopping among these products. A lot of folks are used to just stopping in at their bank and renewing their CDs. It might be good to cast a wider net. BankRate recently did a study where they looked at regional differences in CD rates and found that there could be some appreciable differences, and in some regions where rates tended to be low, they tended to stay low. So it's important to shop around and cast a wider net maybe opt for one of these online products versus just heading into your regional bank and opting for whatever they may have on offer.

Stipp: So what is liquidity is a big issue for me, and I want to make sure that I have access to those funds. Is there any other option where I might be able to put my money and get a little bit more, maybe a few more basis points of return on the yield?

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Benz: Well, credit unions may offer some better deals in terms of money market rates than you get on CDs. The nice thing about credit unions is that they are not-for-profit, and they don't have to advertise typically in the way that banks do. So they are able to send a somewhat higher yield to people who shop around. Don't expect miracles because you are not going to suddenly find 3% rates on money market funds through credit unions, but you may be able to pick up a slightly higher yield by going this route.

Stipp: So a credit union, a little bit different than your bank. Is there anything I need to be worried about there or I should know about a credit union versus a bank?

Benz: Well, one thing to know is that the products that they offer do not offer FDIC in protection, but they do give you a rough equivalent. The National Credit Union Association provides a similar set of protections for people who invest in products via credit unions, and it's also important to know that you won't be able to invest in products in any old credit union. You need to find out if you're actually eligible to participate in that credit union, but don't necessarily be put off, either. So, if even you're not, say, a firefighter that doesn't mean that you might not be eligible to participate in that credit union's products; you just need to ask. So, shop around and do some questioning.

Stipp: Certainly worth looking into.

Benz: Yes.

Stipp: Christine, you mentioned earlier about a lot of our readers actually do have a cash stake that is an important part of their asset allocation. How should I think about that cash stake and is there any way that I can be creative with it, given that I probably do want to have a couple of years maybe in cash for my everyday living needs.

Benz: Well, one thing we've talked about before, Jason, and I still think it's a good idea is to think about this two part cash fund. So, whether you're a retired person or whether you are someone who wants those liquidity reserves--maybe you're worried about your job security or whatever. So, you might think about having that first part in true cash say a CD and then the second part in a high-quality short-term bond fund. We've talked about a few of our favorites, but one of our team's favorites is T. Rowe Price Short-Term Bond.

Stipp: OK. So, CDs, looking into credit unions, having a two-part cash stake--some ways to get a little bit of extra yield that would be probably safer ways to get a little bit extra on what you're holding.

A lot of folks, though, are looking elsewhere. They're trying to find yields that are a little bit fatter than that. This obviously entails taking on some risks. So, what are some less safe ways that people are looking at getting more yield and what should they keep in mind about that?

Benz: Well, I just mentioned the short-term bond fund as being a nice part of this two-part emergency fund. It shouldn't be the whole cash component, and the key reason is that the funds A) do not entail FDIC protections, but another big thing is that some of these funds do dabble heavily in more credit sensitive bonds, so I was looking in the year 2008, for example, which was obviously a huge credit crisis. We saw the typical short-term bond fund had losses in eight of 12 months during that year, and in some cases, in the sort of really dicey period in the fall of 2008, the average fund had losses in some of those months up close to 2%. So, that's, I think, a higher-risk portfolio than the typical cash investor would want to be dabbling in.

Stipp: Another area that's seen an increased interest is bank loan funds. We've seen fund flows go in there. These will adjust as rates go up...

Benz: Right...

Stipp: ... So, it seems like it could be a good idea, but there is a really lot more the story than that.

Benz: Right. So, you're right Jason. There has been a huge stampede of interest in this category, and because the rates on these bank loans reset along with LIBOR, you do get this measure of imperviousness to interest rate rises. The downside, though, is that these too are pretty credit sensitive. So, backing up to 2008 again, what we saw was that the typical fund in this group had a loss of higher than 20% that year.

So, by no means are these funds to be considered some sort of cash alternative. My fear right now is that, unfortunately some investors are looking to them to fill that role, and I think it's a terrible idea.

Stipp: So, given the role that cash really has, it's importance to not have a lot of volatility there, though you may have to live with some shorter rates for a while. But there are a few safer ways to maybe eke out a little bit more if you can give up a little bit of your liquidity in a CD for example. But certainly don't forget that cash is there to be cash.

Benz: Right, exactly, Jason. So, I think some of these ballpark figures that we've been talking about 1%, 2%, 3% at the very high end, anytime you're looking at a yield that's substantively higher than those figures, red flag should go off. You should be concerned that you're taking some excessive risk and not looking at a cash-like product at all.

Stipp: All right, Christine. Well, thanks so much for the tips on your cash investments and for joining me today.

Benz: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.