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Bland CD rates: Try a pinch of stock

Jill FooteThe Fed has vowed to keep the federal funds rate close to zero until at least the middle of 2013. This means yields on CDs will likely stay low through then, too. Meanwhile, those on a fixed income -- specifically seniors -- are scrounging for any low-risk investment with a decent yield. We asked Jill Foote, CFA, Ph.D., to help us with a couple of questions about the current market and CD rates for the foreseeable future. Foote gives her insight into low-volatility stocks and other investments that might help risk-adverse savers manage their portfolios in the low-rate economy.

Foote is currently a senior lecturer in finance at Rice University's Jones Graduate School of Business. She is the director at El Paso Corporation Finance Center and at the M.A. Wright Investment Fund.

QuestionThe Federal Reserve has pledged to keep interest rates on hold until mid-2013. What should senior citizens and others living on a fixed income do amid low CD rates? How can they cope with low savings yields without taking on too much investment risk?

Answer Low interest rates, for an extended period of time, are certainly necessary in the currently weak economic environment. Fortunately for those living on a fixed income, there are some opportunities for higher-yielding investments with some, but fairly limited, additional risk.

First, those living on a fixed income might consider traditional defensive stocks, such as regulated utilities. These high-dividend, low-volatility stocks tend to have steady growth in both recessions and expansions. As regulated entities, these stocks are protected somewhat from volatility related to price changes in commodities and the economy in general.

Along similar lines, for those willing to take some additional but still limited risk, other high-dividend stock products could be fruitful. These would include energy master limited partnerships (MLPs) and real estate investment trusts (REITS) -- particularly those that cover residential rental properties which are currently experiencing significant growth. Both MLPs and REITs trade on the stock markets but have legal and regulatory requirements, which stipulate that they pay out a large portion of earnings as dividends. Similar to the case of defensive stocks, large dividends dampen price volatility in addition to providing current income.

Another potential idea, currently a favorite of billionaire investor Warren Buffett, is investing in the preferred stock of financial institutions. Preferred stock, which has characteristics of both bonds and common stock, provides large dividend payouts and significantly lower volatility than common stock.

Regardless of the lower volatility, (preferred stocks) carry appreciably more principal risk than savings accounts or highly rated bank CDs. Thus, individuals living on a fixed income should always maintain a healthy allocation of these products, even in a low interest rate environment typically characterized by low inflationary pressures. Any greater risk taken to supplement income should be done in moderation and with a keen eye toward worst case scenarios.

We would like to thank Jill Foote, CFA, Ph.D., and senior lecturer of finance in the Jones Graduate School of Rice University for offering her insights. We would also like to thank Greg McBride, CFA, senior financial analyst for Bankrate.com, for providing the question for this interview.

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Product Rate Change Last week
1 Year CD 0.89%  0.01 0.88%
2 Year CD 1.01%  0.02 1.03%
5 Year CD 1.59%  0.07 1.66%
 
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