If you’ve been watching the returns on your savings account lately, you might have noticed the numbers are not as high as they once were. The historically low prime rate, which gets passed along to the rates that savers earn from their banks, has many consumers wondering, Where can I find higher yield?
Before you make the leap from savings and CDs into investment tools with more risk attached, the first question to ask is how much you're willing to invest, says Maurice Quiroga, executive VP and managing director at PNC Wealth Management. "Is it money you're going to need in the short term, such as the next six to 12 months? And if it is, ask yourself if you can take a risk with that money," he says.
Bill Hornbarger, chief investment strategist at Moneta Group, recalls the rule-of-thumb that investors should keep at least three months of living expenses in safe, liquid accounts. "That would be the minimum," he says, recommending at least three to six months of expenses. Quiroga uses a benchmark of keeping at least 3 to 5 percent of the investor's portfolio value in cash, and 7 to 8 percent for retirement-age investors.
Today's 10-year Treasury Bonds yield 2.41 percent, Hornbarger notes, adding if you're considering an investment with a higher rate of return, be aware that you're trading off for some level of risk. He explains, there are three ways to increase yield. "You can go longer: You can have longer-dated bond, which subjects you to more interest-rate risk. You can go weaker: You can go down the credit spectrum into lower-quality bonds, which subjects you to credit risk. Or you can get 'weirder' and take on structure risk." An example of an investment with structure risk is a mortgage-backed security, where the cash flow depends on whether mortgage payments are being made on time.
"There's nothing wrong with taking risk, but you have to understand it, and make sure on a relative basis you're being compensated for the risk you're taking," Hornbarger says. When you're thinking about taking on greater risk for a higher yield, first ask yourself, Where does this fit in my overall portfolio? he suggests.
If higher-risk, higher-yield investments are part of your overall strategy, there are several options to consider. Quiroga explains some of them:
- Municipal bonds: "This is a good option for many people because they're typically vetted by most investment firms, and the default rates are at historic lows." But pay attention to the rating, which could be anywhere from AAA status to C-. "The higher the rating, the better the quality of the bond in preventing default, but you'll have a lower yield because there is higher demand."
- High-dividend stocks: Investing in stock from a utility or telecommunication company can provide good yield, but also has the downside of increased volatility. "You can have some paper loss with regard to your investment if you look at high-dividend paying stocks. But that's a strategy many employ if they're willing to take a little risk."
- Preferred stocks or preferred bonds: This is partial ownership or preferred debt in a company, available through your broker. "You'll get a higher yield than a CD, savings account or municipal bond; but when you look at preferred stock, look at the viability and strength of the company that you're buying."
Deciding among the many available options depends on the investor's personal situation, Quiroga notes. While municipal bonds are generally a safe bet, "the problem is there are very few new-issuance bonds, so Missourians are all trying to buy from the small pool of bonds that are out there, and that will cause brokers to upcharge the bond," he says. High-dividend stocks have more risk, especially for a short-term investor, "But if you have a longer time horizon, the risk does level out," Quiroga says.
A strategically diversified portfolio is important for weathering the variations in the economy, Hornbarger notes. He prefers stocks over hybrid securities like high-yield bonds, preferred stocks and dividend stocks. "If someone is going to take equity-type risk, why not just buy stocks? I'd rather own a basket of stocks if I'm going to take that type of risk."
Whatever your choice, Quiroga stresses the need for liquidity in today's low-interest market. "With a CD, you are locked up. Ask yourself if you want to lock your money up for five years at 1.5 percent, knowing the Federal Reserve is going to raise rates in 2015. This time next year, we'll be having a very different conversation."