Savings Account Rates vs. Four Popular Alternatives

With savings account rates poised to end the year at a little over 1%, depositors are naturally inclined to look at alternative savings and investment vehicles that might offer more substantial returns. That's a good idea, but don't jump ship without considering the tradeoffs. A closer look at some prominent alternatives to savings accounts may well give you reason to live with low savings account rates a little longer.

Savings Account Alternatives

The following are four other places you might put your money, along with some things to consider before cashing in your savings account:

• Certificates of deposit (CDs). Generally, CD rates offer you a better return than savings account rates, in exchange for agreeing to lock up your money for a specified period of time. However, like all bank rates, CD rates are unusually low right now, and short-term CD rates offer little or no advantage over savings account rates. If you are willing to commit to a 4-year CD, you could find rates as high as 3%, but locking up your money for that long might be of special concern with inflation gathering steam. The compound average annual rate of inflation from 1947 to today has been 3.74%. If inflation were to return even just to those levels during your CD term, having your savings locked in a CD at 3% wouldn't look so good anymore.
• Treasury bonds. Another low-risk, income-bearing alternative is Treasury bonds. However, short-term bonds carry yields even lower than savings account rates. You'd have to commit to a 5-year maturity just to get a yield above 2%. With bonds, the longer the maturity horizon, the more the price would decline if interest rates rose--and at today's levels, interest rates have much further to rise than fall.
• Stocks. Frustrated with low savings account rates, you might be tempted to put your deposits in the stock market. Certainly, stocks have a place in a diversified, long-term savings plan. However, putting savings into stocks would shift your portfolio allocation at a time when stocks have already had an extraordinary run-up in price since hitting bottom last March. The Dow Jones Industrial Average has gained about 50% from its low point, one of the strongest intra-year rallies in history. Betting on this to continue would mean defying the odds--and putting a great deal of faith in the economic recovery.
• Gold. This is the popular choice among people who are concerned about inflation. However, since the end of the 1970s, when gold first surged in popularity as an inflation hedge, the average annual return on gold has been only 3.31%--not much of an inflation-beater. This is despite a tremendous rally which has seen gold prices climb by about 346% since the end of 2000 and by about 40% so far this year. The problem is, if you jump into gold at the wrong price, it pays no dividends or interest to help offset your losses. It might just be dead money. Also, buying into gold after such substantial increases in prices means you are not only betting on a return of inflation, but also betting that inflation will be even greater than the expectations of people who have already piled into gold.

While savings account interest rates are low, two key advantages of savings accounts remain intact: security and flexibility. Those attributes may prove to be especially valuable in an economic environment that continues to be uncertain and changeable.

Source:

• Dow Jones Industrial Average Monthly Historical Prices, 1928-2009 • Yahoo! Finance: http://finance.yahoo.com/q/hp?s=%5EDJI&a=09&b=1&c=1928&d=11&e=2&f=2009&g=m

• Statistics on inflation • US Bureau of Labor Statistics: http://www.bls.gov/bls/inflation.htm 

• Modern and Ancient Spot Gold Prices • OnlyGold.com: http://www.onlygold.com/TutorialPages/prices200yrsfs.htm

• Gold Prices • Yahoo! Finance: http://finance.yahoo.com/q?s=GCZ09.CMX

• US Treasury Bond Rates • Yahoo! Finance http://finance.yahoo.com/bonds