Over the past five-years, fixed opportunities have deteriorated for conservative savers of limited means. Here are two possibilities to gain more from your savings -- one is safe, the other has risks.
The past is gone
Over the last few years this column has recommend various alternatives for low-risk investors seeking a boost in income and interest from safe investments. Sadly, the window of opportunity for many of those conservative suggestions is now closed.
Even some of the riskier investments that were out of favor (the best time to buy), like Real Estate Investment Trusts (REITs), Junk Bonds, and certain Blue Chip Stocks have rebounded and are no longer bargains.
The problem
The Fed is determined to hold down interest rates ostensibly to provide cheap capital to corporations to invest in America, “and create jobs and growth.”
Unfortunately, you cannot “create” jobs, you can only create demands. Jobs are the back end of the process of generating demand for goods and services – that someone wants to buy. That is the key – someone must want to buy what a stimulus creates.
When the government takes more of our money in taxes (income tax, sales tax, employment tax, gasoline tax, etc.) we all have less money to spend and less demand is created. Simple enough, but governments are hard learners, and few have ever met a tax they did not like.
Why Cds now pay so little
Because money remains “cheap” by Federal decree, financial institutions do not need to pay savers much in the way of interest to acquire capital to lend. Hence, those individuals (especially seniors on fixed incomes) trying to get by on safe-savings, have become the biggest losers.
Readers that had wisely laddered their CDs are now seeing high-yield old CDs maturing, and the renewal interest rates are ridiculously low. Today, after inflation and taxes take their bite, CDs and money market funds are money-losing propositions. So millions of scrimping American savers have less discretionary income, and consequently spend less for goods and services – so the problem continues.
So what are two of the areas left to consider?
I Bonds
US government I Savings Bonds were designed to provide savers with a safeguard against inflation. They do that, and today they also provide an above average yield when compared to many money market funds, CDs, and savings accounts. An individual can purchase up to $10,000 of electronic I Bonds per year from the Treasury at http://treasurydirect.gov
I Bonds are made up of two components. There is a fixed rate component that lasts for the term of the bond, and a variable inflation rate component that changes twice a year depending on the consumer-price index. To see the current interest rate for I Bonds look here.
An investor only pays federal income tax on I Bonds when they sell the bond, there is no annual income tax due before the sale. I Bonds have the added advantage of being state tax-free – that is an important consideration in high-tax states like California and New York.
There is much more to know about I Bonds, and two articles I have written on the subject will help solve some of the mystery. Click here and here.
High-dividend stocks
High-dividend stocks are much riskier than I Bonds, but are currently paying rates that are better than CDs, saving accounts, money market funds, and EE and I Bonds.
In addition to dividends (cash paid to shareholders), equities (stocks) have upside opportunity and downside risks. In other words stock prices may go up (as they have over the last few years), or down – in which case you can lose some, or even most, of your investment when you sell.
Pros
If a stock price drops, but the company continues to pay a dividend, the dividend payout as a percentage of the stock price rises. That “rising dividend yield” tends to buoy the price of the equity, because the stock becomes more attractive compared to other stocks that do not pay a dividend. The obvious challenge and question is “can the company continue to pay the dividend in a difficult economy.”
Blue chip dividend paying stocks in particular are generally less volatile in uncertain markets.
Another advantage of income from dividends is that except for high-income earners, the maximum dividend tax rate is still 15%, and that may be below the tax rate you pay on earned and interest income.
Cons
A concern about investing in dividend stocks in today’s market is the recent run up of stock prices in general. At the time of this writing, stock prices are nearing their all time highs, even in light of government recklessness and a struggling economy.
In 2012, over $20 billion dollars went into funds and ETFs specializing in dividend paying stocks. This is a scary thing for investors looking for a place to put the proceeds from a recently matured CD. The money to buy those billions in dividend stocks came from other equity funds and ETFs. If you read my column, you know I recommend buying when others are selling, not vice versa.
I believe the lack of reasonable income from safe fixed investments has conservative money chasing dividend-paying stocks in hopes of greater returns, and chasing all stocks in hope of growth. The herd is bullish, the market is near a high point, fundamentals say general stocks are no longer a bargain – so this may not be the best time to buy. On the other hand, the market may continue to grow well beyond previous highs. As they say, "it's a gamble."
Therefore, if you decide to venture into dividend paying stocks in order to boost income, proceed with caution and consider the risks.
Future articles will suggest where and how to start investing in the equity market.
I rarely venture into stock recommendations, but with so few bargains out there, and as one example of a good quality high-dividend company, I really like GE. I believe the stock price has been held down by outdated concerns about GE’s involvement in the global financial debacle, and that should be pretty much behind it. Its dividend, now in the 3.5% range looks safe. I also believe there is good upside potential for the stock of this highly diversified quality company.
Summary
There are few bargains out there right now, so if you invest now, be prepared for temporary market corrections – and only risk money that you can afford to keep in the market during corrections. The price of stocks of well-managed companies customarily comes back, and inevitably, increases in value over time – but you need to have the stomach for the slippery slopes – they are the price of a greater reward.
Good luck and good fortune.
The financial planning advise presented here is in basic terms. Before you act on any financial advice that you read here or elsewhere, be sure to seek the counsel of your financial, and/or tax adviser. There are many roads to financial prosperity, get to know all your options.
