Saving in a low-yield world
savings
Time to take on risk for higher yields?

Green shoots may be sprouting here and there in some segments of the economy, but for savers the yard still looks quite weedy. Short-term deposit rates are discouraging; you have to go pretty far out on the yield curve to find anything that can be considered a halfway decent return.

High-yield six-month CDs, as surveyed by Bankrate.com, are ranging from about 0.9 percent to 1.75 percent.

Yields are tempting

As the stock market recoups some of its losses, seemingly tossing off sour economic reports as though they're yesterday's news and no longer relevant, it becomes very tempting to reach for higher yields by taking on more risk. But experts say this remains a very volatile market and veering from a properly allocated portfolio could be a mistake.

"I'm risk averse and I'm not convinced that we're though this troubled time right now," says John Sestina, a Certified Financial Planner in Columbus, Ohio. "I'd be accepting of low rates but only for short periods of six months. If it's not cushion money, then there are some pretty good high-yield bond funds to consider at PIMCO and T. Rowe Price. But don't risk shock absorber money just because you're getting a low rate of return."

Certified Financial Planner Steve Juetten of Bellevue, Wash., echoes Sestina's caution and says sticking with the asset mix that's appropriately allocated for risk tolerance and time horizon is best.

"My approach hasn't changed at all given the recent markets and low interest rates," Juetten says. "Many people don't understand the complexity of bonds and, as a result, they're looking at one thing -- yield. They don't realize the interest rate risk and the credit risk that they take.

"If you're going to need the money within the next five years then safety is paramount, so staying with lower yields where the principal is insured by the FDIC (Federal Deposit Insurance Corp.) is what you do with your five-year money no matter what the circumstances. If the money is for something longer out than that, then you can afford to take more risk accordingly."

If you're still employed and have a high degree of certainty that your salary is secure, then five years of fixed income may be more than necessary, but many financial planners prefer that retirees have three to five years of cash needs set aside.

Inflation protection

Juetten is recommending that his clients allocate a little more money toward inflation protection these days in the belief that the potential for inflation looms large. He's suggesting that people within 10 years of retirement consider allocating 10 percent to 15 percent for Treasury Inflation-Protected Securities, or TIPS. Those who are very concerned about inflation may want to go as high as 20 percent, he says.

You can buy individual TIPS bonds at the government Web site TreasuryDirect.gov or through an exchange-traded fund such as iShares Barclays TIP bond, or TIP; or through a mutual fund such as Fidelity's Inflation-Protected Bond Fund, or FINPX; or Vanguard's Inflation-Protected Securities Fund, or VIPSX. Many other fund companies have similar products.

"The great thing about a TIPS bond is it's a guaranteed real rate of return, meaning it compensates you for inflation," Juetten says. "You can't say that about any other investment."

There are a couple of things to consider when buying TIPS. If you buy a fund, the value of the fund will fluctuate with interest rates, while an individual bond does not. As long as you hold an individual bond until maturity, your full original investment will be returned. Interest on the individual bond is exempt from state and local taxes.

Be sure to look at expense ratios when buying a TIPS fund. The iShares exchange-traded fund TIP and Vanguard's VIPSX have an expense ratio of 0.2 percent, and Fidelity's FINPX's expense ratio is 0.45 percent. Over time, expense ratios can eat up a lot of your return.

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