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How Can I Earn More on My Safe Money?

Liquidity and principal loss are things to keep in mind.

Susan Dziubinski: Hi. I'm Susan Dziubinski from Morningstar. The Federal Reserve has indicated that it's planning to begin raising interest rates starting in March, but savers are still stuck with some pretty low returns. Joining me to discuss whether it's even possible to earn a higher return on your safe money is Christine Benz. Christine is Morningstar's director of personal finance and retirement planning.

Nice to see you, Christine.

Christine Benz: Susan, great to see you.

Dziubinski: Let's talk a little bit about what's going on in the bond and cash market. Bond yields have been going up, but cash yields have been pretty stubbornly low. What's going on there?

One of the key factors is that during this pandemic, savings rates in the U.S. have really stepped up. And so, savings institutions like banks have found their coffers pretty full. They haven't needed to raise the interest rates that they're paying on savings accounts in order to entice savers to entrust new money to them. So, that's part of the issue--banks just haven't felt the pressure to lift interest rates, and that's been a real headwind for savers during this period.

Dziubinski: For those savers who may be looking for new places that might give them a little bit more yield on their safe money, what are the types of things that they should be thinking through? What are the issues around that?

Benz: Right. I think one of the key questions is, How much safety do you need? Do you need a guarantee that your money will be there? Or are you willing to take a little bit of risk in exchange for a higher payout? If the answer is "I don't want to take any risk at all," well, then you should stick with FDIC-insured investment products where you typically will have to settle for a lower yield in exchange for those guarantees. On the other hand, you may be able to pick up a slightly higher payout by being willing to forgo those guarantees.

And then, I think another key element here, Susan, is whether you need liquidity and how much liquidity you need. So, do you need to be able to have ready access to your cash, or can you sock it away for six months or a year or even more? Typically, if you are able to forgo some of that liquidity, you can pick up a higher interest rate. And the main category there to consider would be CDs. So, if we look at two-year CDs today, for example, these are certificates of deposit, you can find interest rates well over 1% per year. But the trade-off is that you would not have ready access to your funds. You'd oftentimes have a penalty if you needed to crack into that money early. Oftentimes when people talk about safe money, they're using that interchangeably with "This is my liquid money; this is money that I may need to fund near-term expenditures." So, keep liquidity in mind and use that to help direct where you go.

Dziubinski: And then, how do credit unions fit in here?

Benz: Well, really interesting, Susan, in that credit unions oftentimes do offer pretty competitive payouts relative to what you might get from commercial banks. And the key reason is that credit unions don't do marketing. They oftentimes don't have brick- and-mortar locations. So, they're able to keep their expenses down. That allows them to be pretty competitive in terms of savings rates and also rates that they extend to borrowers. So, this is something that you should check out if you're in the market for savings opportunities. The lift that you might get in terms of the interest that you receive isn't especially great, but it's still worth investigating, especially if you're saving a nice chunk of change. So, I would look at the National Credit Union Association. They have a nice credit-union finder that you can search on credit unions based on your geographic locale and other factors. That's definitely something to check out for savers.

Dziubinski: And then, what about reaching for higher yield through bonds, maybe a short-term bond fund or an intermediate-term bond fund? What should investors be thinking about there--or even a floating-rate fund? Is that something to really think about for "safe money"?

Benz: Well, I think you want to tread carefully as you move into bonds and understand that there is the possibility of principal loss with these products. But here I think time horizon can be really instructive in terms of deciding what to do. So, if you have a very short time horizon of less than a year, for example, I would absolutely stick with cash. On the other hand, if you have a slightly longer time horizon, I think a high-quality short-term bond fund is probably OK. You might have some modest principal bobbles, but you probably will have the opportunity to pick up a slightly higher yield.

When we look at the performance of high-quality short-term bond funds over history, we see that, over one-year periods, they have losses of roughly 6% of the time and those losses are in the neighborhood of 2%. So, that suggests that if you have a time horizon of at least a year, you might have some losses in a short-term bond fund, but they probably won't be very deep or very frequent, and you may be able to earn a higher yield. Intermediate-term bonds, I think, you obviously would want to have a longer time horizon of more like three years or longer. Because similarly, when we look at rolling three-year periods, we see that intermediate-term high-quality funds--not the core-plus bond funds, but the intermediate-term core bond funds--have a pretty low probability of having losses over a three-year period and to the extent that they might have those losses, they'd be pretty shallow as well.

You mentioned floating-rates investment product, Susan. I think that people are attracted to these products in part because they can see boosts in their yields actually when interest rates are going up, as they have been doing. But the trade-off is that they're really credit-sensitive. They're sensitive to what's going on in the economy and in the stock market, so I wouldn't recommend them for anyone's safe assets. In fact, in my Model Bucket Portfolios, I hold floating-rate products in the Bucket 3, which is your risky equity bucket, where you're having a nice, long time horizon for that portion of your money.

Dziubinski: And lastly, Christine, you say that it's important to not just limit the thinking about safe investments to your investment portfolio. What do you mean by that?

Benz: Well, I mean that you want to look at your total opportunity set. So, for a lot of people, they do have some loans with an interest rate attached to them. And I think you can think of paying down those loans as akin to a safe return on your money. In fact, it's kind of a guaranteed return on your money. So, even if you have a nice low mortgage rate, for example, and you're looking for other safe things to do with your funds and you don't have that imminent liquidity need, that debt paydown I think can be a really smart answer. And of course, your need for safe investments really depends on your own situation. I would say that for young folks who happen to have mortgages, that's probably not the best return on their funds. But for people inching closer to retirement who want to try to embellish their peace-of-mind investments, I think that putting money toward the mortgage paydown can make a lot of sense.

Dziubinski: Christine, thank you for your time today. These are really insightful ideas for us to be thinking about when it comes to our "safe investments." We appreciate it.

Benz: Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.