Rates are Falling

 Rates Are Going Down - What Should Savers Do?  Savers are in a pinch.  Now, the situation looks to get even uglier.  

The Federal Reserve has cut interest rates 1 1/4% so far in 2008.  CD rates at local banks have fallen below 4%.  You might want to check the rate on your savings account; many are as low as 1%.  As the economy continues to slow, you will see even lower rates by this summer.   Inflation in 2007 was 4.1%.  After you pay taxes on the interest you earn, and after your loss of purchasing power from inflation, you are losing money hand-over-fist.

 

Two things are pushing rates lower:  the slowing economy and the need to protect individuals who took out variable rate mortgages.  The sub-prime mess will push a lot of people out of their homes if rates go any higher.  In some policymakers’ eyes, it is in our country’s best interest to protect this massive group of people, even at the expense of savers.

 

I have been receiving numerous calls lately asking for advice.  People are nervous about the stock market, but they can’t stomach the low rates at the bank.  “Isn’t there something in between?”, they ask?

 

First, we all need some emergency money stashed away.   The loss on this money is the insurance premium we all pay to have our money ready and available when we need it most.  But most savers have too much sitting in low interest earning accounts.   I would guess that $20,000 is plenty for most people.  

 

Second, you should be saving for those big purchase items.  If the purchase will be in 2008, a savings account is still the best place to park your money.

If your goals for your money are more than three years away, or like most people the money is ear marked for nothing in particular, you need to make your money work harder for you.  I have worked with people who are losing thousands of dollars in potential earnings every year.  This money could be improving your financial future or allowing you to take that special vacation. 

 

I actually project that falling interest rates will help the stock market.   After people have taken care of their emergency and short term needs, where are savers going to put their money?  Eventually they will turn toward stocks and other alternatives, and so should you.

 

Here are a few examples:

 

1. If you want a long term nest egg.  One way to move closer to that objective is to build a diversified portfolio of both stocks and bonds. When stocks are down, the bonds provide stability and income.  When you need cash the bonds will be there for you in your time of need.  Over time, stocks always return more than CD’s.  Stocks will add the kicker to help your returns exceed those offered by the bank. 

 

1. If you are looking for higher income consider Preferred Securities. Most people have never heard of preferred securities, but they have been a special little niche of mine, and have helped many of my clients earn a high income.  Every three months you receive a nice dividend check that can range from 6% to 9%.  But everything has two sides to the coin. The prices tend to fluctuate around $25 a share, but they do move around like a stock.  Sometimes my clients collect their dividends plus an increase in price, and sometimes the price moves down.  Typically the price is within $5 from $25.  If you just buy and sit tight, the dividends pile up over time.  I recommend these investments for individuals with at least a three year investment horizon. 

 

1. Another strong addition to a diversified income portfolio is Bond Mutual Funds:  My favorite fund is the Pimco Real Return Fund.  90% of the bonds inside this fund are rated AAA.  Pimco returned over 11% in 2007.  I don’t anticipate that they can pull this off every year, but they have averaged over 7.5% for each of the past ten years.

 

1. How many years have your watched Warren Buffet’s company Berkshire Hathaway share price go up and up?  Many consider his stock to be safer than a mutual fund, and it has averaged over 15% year after year.  With the price down 10% from its high, isn’t it time to consider buying some?

 

1. High Dividend Stocks can be a prudent buy right now.  With the decline in the stock market prices, many blue chip dividend stocks are paying 4% to 6%.  In addition to the quarterly dividends, you will share in the capital gains once the market recovers.  By the way, dividends and capital gains are taxed at rates much lower than interest income. 

 There are a lot of other alternatives out there that I follow on a regular basis.   If you have too much cash sitting in your money market, or you have a CD maturing soon, you owe it to yourself to look at higher earning choices.   

Ron Dickinson, CPA, CFP®, MPA-tax