Saving in a low-yield world
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5 savings strategies before CD rates rise

Today's record low interest rates will not last forever.

Federal Reserve Chairman Ben Bernanke recently told the House Financial Services Committee that given current economic conditions, the federal funds rate is expected to remain at "exceptionally low levels for an extended period."

However, rates -- which have hovered near record lows for an extended time -- have nowhere to go but up, and likely will begin rising once the U.S. economy regains its footing.

"The moment there is a sniff of economic expansion or a weakness in revenue and receipts of the U.S. government, we will see interest rates rise," predicts Curt Lyman, managing director of HighTower Advisors in Palm Beach Gardens, Fla.

While rising rates are bad for people with credit card debt and other loans, they can be a lifesaver for people on fixed incomes who depend on steady returns from CDs, savings accounts and other vehicles tied to interest rates. Fortunately, there are moves savers can make today that will pay off once rates begin to rise.

Ready for rising rates:
  1. Choose short terms over high yields.
  2. Stay liquid.
  3. Consider adjustable-rate CDs.
  4. Build a CD ladder.
  5. Look into TIPS.

Choose short terms over high yields

Savers typically sock money away in whatever instrument has the highest yield. However, this might not be the best strategy today.

"When rates drop as low as they have, all too often investors reach for yield, all too often with dreadful consequences," Lyman says.

Locking into a safe but low-yielding CD might seem prudent now. But a five-year CD yielding 2 percent or 3 percent might not look so great if interest rates rise sooner than expected, as some experts predict.

In fact, a sudden spike in interest rates would mean savers stuck with low-yielding CDs would actually be losing ground.

For those who think interest rates will rise soon, "your only protection is to stay in shorter-term stuff and console yourself that it's better than putting your money in your mattress," says Walt Woerheide, vice president of academic affairs and dean of The American College in Bryn Mawr, Pa., which focuses on the development and training of financial services professionals.

To prepare for higher rates in the future, it makes more sense today to accept CDs with lower yields and shorter terms instead of chasing yield. For example, right now the difference in yield between a one-year and a three-year CD "is really not all that much in absolute terms, given the potential opportunity loss," Woerheide says.

Robert Sumner, president of First National Bank of Pasco in Dade City, Fla., has seen plenty of financial ebbs and flows in his more than 40-year banking career.

"To me, it's a natural phenomenon," he says.

Sumner doesn't expect rates to start rising before the beginning of next year, and thinks the middle of 2010 is a more likely bet. Savers who agree with this timeline should stick to CDs with terms no longer than six months, Sumner says.

Consumers who think rising rates are at least a year away may want to consider CDs with a 12-month term, he says. The difference is about 0.25 percent.

Stay liquid

For many savers, highly liquid accounts are an even better place to keep money than short-term CDs. Checking, savings or money market accounts may not have yields as high as CDs. But what they sacrifice in yield, they gain in liquidity, offering added flexibility for savers.

Sumner says he's seen an upsurge in interest in money market accounts, where -- unlike a CD -- the money is available as needed.

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Investors "don't want to take a chance of being locked into a rate long term," he says.

Joe Spada, managing director at Summit Financial Resources in Parsippany, N.J., says if a money market account pays 1.2 percent, and a five-year CD pays 2.8 percent, the temptation for consumers might be to put their money where it earns the highest immediate return.

"If interest rates increase a year from now and a money market is paying 4 percent, you're locked in to 2.8 percent," he says. "People have to be wary about trying to stretch to get yield."

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