Getting Personal
Low rates on savings
Question: If credit and money is so difficult to get right now, why are savings accounts still yielding only around 2%? Why can't we savers get a better deal? I remember routinely getting 6% at our credit union years ago, but that is long gone. Retirees and near-retirees want to know. Diane, Sinking Spring, PA
Answer: While Congress, the White House, the presidential candidates, powerbrokers, scholars and others struggle to come up with a way to contain the credit crunch, the immediate concern on Main Street is more prosaic and equally consequential: Will the money my family has set aside for everything from paying for car repairs to meeting a tuition bill to paying for high blood pressure pills be there when needed? Put somewhat differently, "what is the safe harbor," asks Zvi Bodie, finance professor at Boston University.
The answer is that there are several "safe harbors." Many are fleeing into a handful of options that are essentially risk-free parking places for money. The trade-off for a no-risk to low-risk safety net is a low interest rate and a low investment return. All the savings options involve relying on U.S. government backing rather than private sector promises.
Take short-term Treasury bills. Investors from around the world have decided to seek safety in T-bills. As I am writing this, investors are willing to get paid an interest rate of a mere 0.81% in return for owning a default-free investment, the 3-month T-bill.
You can do a little bit better with money market mutual funds that invest solely in short-term Treasuries, but not by much. For instance, the yield on the Vanguard Treasury only money market mutual fund is about 1.6%. And, of course, you mentioned your savings account. Well, assuming the deposits are insured by the FDIC, no one has lost a penny since the government's bank insurance fund was established in 1933 if the accounts had less than the insured limit. It looks like Washington is moving toward raising that limit even more, perhaps to $250,000. The $100,000 limit is something of a misnomer, however. It's relatively easy to park a multiple of that sum at the same bank and still get the total insured by the FDIC.
Again, because of concerns over safety--will my money be there when I need it--banks don't have to pay you much for your savings. The rates of certificates of deposit or CDs have gone up recently, but not that much.
One other point: Despite consumer inflation up over 5% so far this year, fears of inflation are receding. Higher inflation rates can drive up interest rates. But with the U.S. economy in recession, debt imploding, and the global economy slowing down it's hard to see the over all price level climbing higher anytime soon. (Nevertheless, I am a big fan of Treasury inflation protected securities, better known as TIPS. These default-free securities protect the investor from the ravages of inflation if it does ever pick up. TIPS offer a fixed interest rate above inflation as measured by the consumer price index (CPI). The bond's principal is adjusted as the CPI changes. That said, TIPS have one drawback for safety-minded individual investors: Taxes. In essence, Uncle Sam requires owners in taxable accounts to pay income taxes on inflation-adjusted gains before getting any of inflation-adjusted money at maturity. The trick to avoiding the tax hit is to own the bonds in a tax-deferred retirement savings account.)
Today's very low interest rates are painful for many savers, especially retirees. Still, my own feeling is that the trade-off is worth it.
IQuestion: Why can't we savers get a better deal? Retirees and near-retirees want to know. Diane, Sinking Spring, PA
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Comments (6)
October 1, 2008 1:53 PM PT
Some municipal money market rates are through the roof, though. (Vanguard's state-specific munis are yielding 6%+! and that's all tax free!) Does that mean that these are risky assets? Or simply that the flight to Treasuries is so great that the demand for munis is low, resulting in the wild yields?
--Johan
October 1, 2008 2:06 PM PT
Its amazing, isn't it? It's also a sign of how crazy and scared the financial world is right now. In the 35% federal tax bracket you'd have to find a taxable yield of more than 8% to compete with a muni money market muutal fund.
That said, with short-term tax exempts there is greater risk with the economy turning down and financial problems spreading in a number of communities. I think for a number of people the extra risk is worth it--but there is a risk.
In my answer I focused on essentially risk-free savings places in my answer.
By the way, I did go to the Vanguard site, and this is what it has to say about munis as of September 25:
What's causing yields to rise for tax-exempt money market funds?
The yields of Vanguard's municipal money market funds have risen dramatically in recent days. In a reversal of the usual relationship between yields of municipal and taxable money market funds, the yields of Vanguard Tax-Exempt Money Market Fund and similar state-specific funds have risen far above those of taxable funds, including Vanguard Prime, Federal, and Treasury Money Market Funds.
The unusual situation is being caused by current conditions in the short-term debt market. Many firms that help create and market short-term municipal securities for state and local governments are finding they need to boost yields to create greater demand for these securities. As a result, securities with extremely short maturities—including those that mature in one day or one week—are being offered at exceptionally attractive yields.
A word on Vanguard money market funds
The recent bankruptcy filing by Lehman Brothers Holdings Inc. and widespread turbulence in the financial markets have prompted a number of questions about the impact on Vanguard funds, including money market funds. Vanguard is confident in the credit quality of its money market funds, all of which are managed with the objective of maintaining a stable net asset value of $1 a share.
As part of their normal operations, Vanguard's tax-exempt money market funds purchase these kinds of short-term securities every day, causing the funds' yields to move in step with the yields being offered in the marketplace.
"These unusually high yields are simply a function of how the money market arena is reacting to events in the credit markets right now," said Pamela Wisehaupt Tynan, who oversees Vanguard's municipal money market funds. "These yields are not coming from lower-quality securities, nor are they related to problems with the creditworthiness of municipalities."
Ms. Tynan said it is difficult to predict how long the current unusual money market conditions will last. She noted, however, that municipal issuers historically have had extremely low default rates. "In fact, agencies that rate municipal bonds are currently reviewing thousands of municipal issuers for possible ratings upgrades, in recognition of their relative safety compared to other issuers of short-term debt."
Ms. Tynan added that Vanguard's highly skilled and experienced credit analysts continue to consider only high-quality municipal money market instruments. "We're confident in the credit quality of our money market funds. They have ample liquidity given their considerable holdings in high-quality municipal issues."
Notes
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.
Investments are subject to risks.
Investments in bond funds are subject to interest rate, credit, and inflation risk.
Past performance is no guarantee of future results.
October 2, 2008 4:54 AM PT
Online savings accounts are doing a bit better. Countrywide Bank for example is offering 3.4%, a tiered rate that kicks in at $10,000 in an FDIC insured account. Countrywide also has a 7 month CD paying 3.9%.
October 2, 2008 7:47 AM PT
If you are using a savings account or even a CD, you are losing money right now. The amount of money being printed guarantees purchasing power to fall sharply (think Wiemar Germany). The idea that you get a lower rate for safety is a farce.
The loss of value to inflation and tax on the nominal interest return, means that extra money should be parked in tangibles (food, silver, etc) to preserve wealth though this inflationary end game of the US dollar.
October 6, 2008 1:58 PM PT
"Today's very low interest rates are painful for many savers, especially retirees. Still, my own feeling is that the trade-off is worth it. "
Are taxpayers providing capital to the banks simply so that the banks can avoid paying depositors higher interest rates?
That's how it looks.
October 6, 2008 2:57 PM PT
i don't know if i by this lower RoR is due to "saftey."
Most of the banks failed w/in days or hours of the public learning that they were in trouble so there is no way for the average person to know which bank is safe and which isn't. if we can't identify a who is safe then there can't be lower rate to justify the precieved saftey.
the only thing that makes sense to me is that maybe as banks fail and people get thier money from the FDIC they are moving it to other banks. Fewer banks getting more instant deposits could = lower RoR.
On the other hand if the surviving banks have this influx of cash how can they be struggling find cash to loan?
Todd in Rochester