Q: Is there a middle-ground type of investment between the low interest rate of, for example, a certificate of deposit, and the high risk of stocks?
A: Yours is a timely question because the extreme low interest rates of recent years seems to have widened the gulf between deposit accounts and the stock market. While there is no perfect middle-ground investment, you do have some options for bridging the gap to some degree.
According to the Federal Deposit Insurance Corporation, 1-month CDs currently pay an average of just 0.06 percent in annual interest, and savings accounts have the same average rate as well. This means it is particularly unrewarding to sit on the sidelines if you want to avoid the risk of the stock market. As a consequence, people are relying on stocks more than they normally would, which only serves to drive stock valuations to even riskier heights.
So, what can you do to get a little better return without submitting to the full volatility of the stock market? Some options are listed below.
While none of the following is an ideal, best-of-both worlds type of solution, they are ways to get a little bit better return without accepting the full risk of the stock market:
- Look at longer CDs. If you can commit to CD accounts for a little longer, it can make a big impact on how much interest you earn. At 78 basis points, 5-year CD rates are currently paying 13 times what 1-month CDs yield.
- CD laddering. If you do not want to lock all of your money up for five years, consider a CD ladder - a series of CDs set to mature on different dates. This will allow you to benefit from the higher rates offered by longer-term CDs, while still having some of your money becoming available at regular intervals.
- Shop around for your CDs. It pays to compare rates to find the best CD rates. For 5-year CDs, the best CD rates are nearly three times the national average, and for 1-year CDs the best CD rates are more than five times the national average.
- Consider high-quality bonds. Longer-term bonds are yielding more than CDs, so if you can put up with some interim volatility, you could own an investment vehicle that will pay you more interest and be guaranteed to pay its full face value upon maturity. Just be sure you focus on high-quality bonds like U.S. Treasuries because corporate bonds would expose you to some of the same economic risks as the stock market.
- An asset allocation approach. Of course, deciding between stocks and lower-risk alternatives is not an all-or-nothing proposition. A blended asset mix with a limited stock allocation could give you some chance at higher returns without taking on full market risk.
There is no easy solution to this problem, nor is the cure going to be very pleasant. Higher interest rates would offer bank depositors and bond owners better returns. But on the way there, the rise in interest rates could be very disruptive to the stock and bond markets.
For more information on CD rates for your savings, visit the MoneyRates CD section.
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