Making the best of low-interest savings
have been running on a treadmill toward higher interest rates --
as time passes, there is no real progress. The misery of investors
has been cause for celebration for borrowers as interest rates remain
historically low, with a cloud of uncertainty keeping them low.
The forecasts made by the economists at 24 of Wall
Street's biggest bond dealers in January 2002 tell an important
story. In developing forecasts for 2002, 21 of 24 said interest
rates would first begin to rise sometime in 2002, which was the
prevailing viewpoint at the time. Only three saw the Federal Open
Market Committee not boosting rates until 2003, though none foresaw
the half-point interest rate cut in November 2002 that brought rates
to a 41-year low.
What this illustrates is the difficulty of forecasting
in an ever-changing world, even for some of the best-educated and
well-respected Wall Street professionals. Just as rates have remained
lower, for longer, than anyone first envisioned, the opposite could
very well be true when rates one day begin to climb.
weeks ago in this space, the prudent steps for borrowers --
debt consolidation and debt repayment -- were addressed.
So how can savers best make lemonade from the lemons
of low interest rates?
For those individuals dependent upon interest income,
a laddered portfolio can and will afford greater protection from
interest rate volatility as cash investments are diversified over
a range of maturity dates. A laddered portfolio is one in which
an investor buys a series of CDs with staggered maturity dates.
Investors thus avoid rolling over their entire CD portfolios at
a low point in the interest rate cycle. In low-yield environments
such as today's, investors with laddered portfolios do better.
Take, for example, an investor with a portfolio of
five-year CDs laddered to mature at annual intervals. Only 40 percent
of this portfolio has been reinvested at sub-normal yield levels
and, assuming no dramatic improvements for the remainder of 2003,
by year-end 60 percent would have been reinvested. But even then,
the other 40 percent would still be chugging along at much higher
interest rates, including the portion invested in 2000 at what was
then a five-year high.
Just as the laddered structure has provided protection
in a time of continually declining interest rates, it would also
benefit the investor in an environment of abnormally high interest
rates by reinvesting at progressively higher rates. Don't think
this will happen? Remember, no one foresaw the current state of
interest rates as recently as 13 months ago.
What about those not dependent on interest income
who have dutifully dispatched of high-interest debt such as credit
cards, and refinanced the mortgage at rock-bottom interest rate
levels? Consider using the extra cash to rebuild the safety net
or emergency fund. Check out high-yield
money market deposit accounts as a way to keep pace with inflation
while preserving liquidity and having the protection of FDIC insurance.
The presence of this safety cushion provides greater
flexibility for future investments or expenditures, but is a preventative
to incurring debt at higher future interest rates should unforeseen
Savers may be running on an interest rate treadmill,
but certain actions now will help keep the finances in tip-top shape
regardless of how flat or steep the grade of interest rates becomes.
Greg McBride is a financial analyst
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