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How to Retire in a Low Interest Rate Environment

For Americans hoping for bigger yields out of their savings accounts and CDs, the wait continues. Faced with anemic economic growth, the Federal Reserve has kept rates near zero so far this year. And even when Janet Yellen and company loosen up monetary policy, experts say it could be years before yields reach anything close to their historic norms.

Low interest rates have been great for consumers looking to take out mortgages or car loans, but they have been less appealing for those who want to park their cash somewhere safe. The typical rate on savings accounts is now just 0.54%, according to BankRate.com at press time, and the return on a one-year CD is a paltry 1.09%.

That is a particular problem for people in (or close to) retirement. Rates like we've been seeing can make it feel like saving is not a virtue, tdespite what we've all been taught – at least saving in the traditional places retirees have been advised to save. But those are not your only choices.

Short Term vs. Long Term

If you’re looking short term, not necessarily. For any assets you may need to access within a couple of years, an FDIC-insured account – whether it’s an account at your local bank or a certificate of deposit – is still your best bet. That goes for your emergency fund, which experts say should equal three to nine months’ worth of living expenses.

Keep in mind, though, that you can often do a little better with an online bank account than one at a traditional brick-and-mortar operation. Ally Bank, one of the leaders in this space, is currently offering a 1% yield on savings accounts, with no monthly maintenance fees. 

When it comes to money you won’t need for a few years, your possibilities increase. There are a number of investments that offer the possibility for considerably better yields, albeit with slightly higher risk.

Bonds

One of your primary options, of course, is the bond market. Unless you have a long time horizon, think in terms of safe, highly rated debt instruments. Exchange-traded funds (ETFs) that focus on investment-grade corporate debt are a prime example. (For more, see XLF vs. KRE: Which Interest Rate Performs Better in Low Interest Rate Environment?)

In the current environment diversification becomes more important than ever. That’s because investors become susceptible to something called “rate risk.” When interest rates inevitably rise, the price of bonds will go down. This becomes less of a problem when you own a mix of bond funds with different maturities. Those funds may take a hit on their longer-term bonds, but they can reinvest in new bonds that now offer a higher yield.

REITs

Another alternative for intermediate-term needs are real estate investment trusts (REITs). These dividend-paying instruments own or provide financing for a portfolio of commercial properties. The value of REITs can fluctuate in the short term, but because a lot of their income is generated through existing leases, REITs are usually considered a safer play than growth stocks, for example. (For more, see REITs: Still a Viable Investment?)

The conventional wisdom is that interest rate hikes tend to hurt the performance of REITs, at least in the short run. The reality, however, is that any rate increases are likely to be gradual, which mitigates the risk of any significant devaluation. REIT ETFs provide an easy way to diversify your real estate holdings and increase your liquidity. Over the past year the Vanguard REIT Index Fund (VNQ), which tracks the broader REIT market, yielded a respectable 3.87% return.

Dividend-Paying Stocks

When your time horizon is only a few years out, investing in tech startups probably isn’t your wisest move. Stocks that have a record of paying a stable dividend, however, are a different story. For instance, this past year Coca-Cola (KO) offered a dividend yield of 3.14%, and utility giant Consolidated Edison (ED) provided investors with a 3.66% yield. Compared to what you’d be getting from a CD or T-Bond, those numbers look pretty attractive right now. (For more, see The Top Dividend-Paying Stocks of 2016 (GIS, JNJ, MSFT).

The Bottom Line

Saving is still a virtue to ensure that you have both emergency money and funds to invest in other places. For money you may need to tap in the short run, you’re better off living with sluggish interest rates in order to enjoy the security of an FDIC-insured account.

Nevertheless, if you’re looking out a few years, a carefully assembled portfolio of bonds and other dividend-paying vehicles might give you a bigger payout. Even if you're approaching or in retirement, it makes sense to expand your safe-investment options.

 

 

 

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