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Are Low Interest Rates Killing Your Savings? Here’s What to Do.

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With interest rates at historic lows for loans and deposits, the current rate environment certainly rewards borrowers but what choices are long-term savers left with? Quick Answer: Invest. But keep reading if you enjoy a slow burn…

When it comes to deposit options my colleague Sarah has written a great article that helps savers make the most out of their short-term cash deposits. Many, if not all, of us have both short- and long-term needs when it comes to managing our finances. Savings and money market accounts are often best for short-term financial goals. Money that you’re not planning to spend for three to five or more years can be placed in a long-term savings instrument and could open more opportunities to grow your assets. This article intends to share high-level details about deposit account alternatives for long-term savers and investors. Remember, each of your financial situations is unique so it is wise to speak with a financial advisor before making any major decisions.

 

WHAT’S RISKY ABOUT A CD?

It’s important to note that all financial choices involve risk. As a financial advisor, I look at risk differently than most people I speak with. Would you consider putting your long-term savings in a CD risky? The likely answer is “of course not,” and although there is no risk to the principle amount deposited, there is a high likelihood you’ll experience purchasing power risk because CD deposits do not generally grow at a rate faster than the cost of goods and services around you. This is the primary risk that savers face when the interest rate on their deposits is lower than the rate of inflation. The same $20 bill in your wallet buys fewer jars of peanut butter now than it could have a few years ago. By investing the money you intend to spend in the future, you increase the likelihood that your money will buy the same amount or more of the goods and services you’ll need later.

 

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HOW DIFFERENT TYPES OF RISK CAN AFFECT YOUR SAVINGS

Now that I’ve shared my $.02 about risk, let’s illustrate a clear hierarchy of financial investments starting with the least risky and ending with the highest concentration of market risk:

One step out from cash in a CD would be a fixed annuity. This is an insurance company product that acts, in many cases, like a CD. It will have a fixed rate of return and a fixed term, and is guaranteed against loss by the financial strength of the issuer and their ability to make good on the contract. Deposits made into an annuity are called premiums and oftentimes the owner of the fixed annuity will be required to make a single premium payment, much like a CD. Other key differences are that annuities grow tax-deferred and have limited liquidity (most allow you to withdraw only 10% of your investment per year), and are assessed steep surrender charges unless held to maturity. Once the contract matures, the investor can annuitize the contract and begin to receive lifetime income payments, surrender the contract without penalty and take a different route, or renew for a new term.

One more step out on the risk scale and we arrive at Bond Funds. These instruments are mutual funds composed of bonds. They are professionally managed by the fund company and there are many flavors to choose from. Broadly, bonds represent a debt obligation between you and the issuer and are used as a source of income in many investor’s portfolios. As a bondholder, you receive regular dividend payments and at maturity you get your principal back. In the case of a Bond Fund, which represents sometimes hundreds of bond issuers, the fund managers are responsible for managing the credit and reinvestment risks associated with individual bond ownership. As a shareholder of a bond fund, you can withdraw money at any time and each year the fund will send you a 1099-DIV clearly stating your dividend income for the previous year. The downside? There is oftentimes a fee associated with purchasing new shares of the fund and each fund has is assessed annual fees to cover the management of the portfolio. The fees are based on the gross expense ratio, which is assessed as a percentage of your account value, oftentimes less than 1% per year.

Another option is to own individual bonds. This is a more complicated option and requires that you purchase the debt of an individual company. The risk here is that the company is unable to meet its debt obligation, goes out of business, or calls the bond back. In any of those scenarios you would stop receiving income and in the case of bankruptcy could lose some or all the principal as well.

From here, we head toward mutual funds, which combine stocks and bonds, often referred to as “growth and income” funds as they have underlying securities seeking both outcomes. Mutual funds often have a dual mandate of generating current income while also seeking long-term capital appreciation (growth). Their portfolios are often described by the percentage of stocks to bonds, or asset mix. You may have heard terms like “60/40 Balanced Fund” which is telling us that 60% of the holdings are stock-based and 40% are fixed-income or bonds. Generally, the more the portfolio tilts toward stocks the higher degree of volatility and risk for short-term price changes. It is important to note that there is no stated rate of return for any market-based product, so we are forced to look back at past performance knowing it is not indicative of future results.

The key is moderation. It is always prudent to keep plenty of cash available for emergencies and planned future expenses, but keeping too much money in low-interest accounts can have a harmful effect on your future ability to maintain a similar lifestyle in retirement or generate income from your assets. The foundation for any financial plan is a solid understanding of your goals and a working budget. From there, it might make sense to sit down with a financial professional and start developing a long-term savings and investment plan.

 

Representatives are registered, securities sold, advisory services offered through CUNA Brokerage Services, Inc. (CBSI), member FINRA/SIPC, a registered broker/dealer and investment advisor, which is not an affiliate of the credit union. CBSI is under contract with the financial institution to make securities available to members. Not NCUA/NCUSIF/FDIC insured, May Lose Value, No Financial Institution Guarantee. Not a deposit of any financial institution. FR-3468086.1-0221-0323

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