Where to invest when interest rates are low - 6 fixed-rate vehicles that offer the best returns
- Low interest rates are challenging for income investors, as fixed-income assets pay less.
- Among banking products, CDs and online savings accounts offer better yields.
- Corporate, municipal, and junk bonds offer higher rates than US Treasuries, at varying degrees of risk.
The 21st century is developing into an era of steadily declining interest rates. At the beginning of 2000, the benchmark US federal funds rate hovered around 6%; as of December 2020, it stood at 0.09%. According to the Federal Reserve, which establishes monetary policy in the United States, rates will remain near zero through at least 2023.
The interest rates lenders charge and that investments pay are pegged to the fed funds rate. So low interest rates have become a fixture in finance.While the scenario creates advantages for some - companies and people taking out loans, or seeking to refinance their mortgages - it can be a problem for others:
- Bank account-holders see their savings and money market accounts earning less.
- Permanent-life insurance policyholders who fund their premiums out of their policies' accrued cash value might have to pay out of pocket.
- Those dependent on investment income find it harder to find good, safe sources of revenue.
But with interest rates hitting historic lows, there's a greater onus on fixed-income investors to develop alternative investment strategies to traditional deposit accounts or US Treasury bonds. And to make the numbers work, the strategy may require taking on greater risk.Here, in rough order of increasing risk, are some of the better-paying fixed-interest investment options during a low or declining interest rate environment - where to go when interest rates are low.
Online Savings Accounts
Traditional bank savings accounts, arguably the most plain-vanilla of investments, pay approximately the same annual rate as the monthly yield on Treasury bills - which currently is close to zero, in some cases. Online savings accounts offer a slightly higher yield. The digital banks' lack of overhead allows them to pay out more than their brick-and-mortar counterparts. Just be sure the institution is FDIC-insured.
Certificates of DepositInvestors sometimes also receive slightly higher rates than on savings accounts with certificates of deposits (CDs). The rate remains constant for the term of the
The tradeoff to gaining these features is typically a slightly lower yield.
So, moving a portion of your fixed-income funds into a CD could be a savvy move. You could also try laddering the CDs, buying certificates with varying maturity dates, allowing for more liquidity.
Corporate BondsFixed-income investors often look to the bond market to achieve a higher yield than that of bank products and accounts. Bonds as a class are considered conservative and suitable for fixed-income portfolios - especially US Treasury bonds. But when Treasuries are yielding next to nothing, where else can you go?
One option: Corporate bonds, issued by companies seeking capital. They carry a higher risk than US Treasury bonds but are considered reasonably safe from default - as long as you stick to companies with strong balance sheets and financial histories.
The bonds of these companies typically carry a letter grade from an independent credit rating agency, like Moody's, Fitch, and S&P. Look for bonds with ratings of AAA to BBB. These are considered "investment-grade" - the least-risky bonds.
High-Yield Bond ETFsBonds rated below BBB go by several names: "non-investment-grade," "high-yield," or, most notoriously, "junk bonds." As these names imply, these bonds pay better interest rates, but are in greater risk of default, than their investment-grade counterparts.
Often referred to as munis, municipal bonds are issued by cities, counties, and states to finance public construction or infrastructure projects. They offer both higher yields than bank deposit accounts and also advantages at tax time. They are exempt from federal income taxes - and also from state and local taxes, for investors who live in the state issuing them.Munis' stated interest rate is less than corporate bonds' - because it's tax-free. Often the two equal out, when you factor in the tax you'd owe on the corporate bond. Of course, the higher your tax bracket, the more advantageous the muni would be.
Like corporate bonds, munis come with letter ratings. The safest are called general obligation bonds (GO), which are backed by the issuing governmental entity itself, and not by revenue from a specific project.
Defined-maturity bond fundsWhile it's possible for investors to invest directly in individual bonds and hold them until maturity, the effort can be expensive and time-consuming. Defined-maturity bond exchange-traded funds (ETFs) invest in thousands of different bonds, all held in a single fund. Each fund offers a stated maturity that dictates when the fund closes and when the net assets are distributed to investors. In essence, defined-maturity bond ETFs combine the best of both bond funds and individual bonds. Bond fund ETF yields depend on the type of bonds held in the fund (corporate, muni, high-yield) as well as the maturity of the fund, usually from one to 10 years. Of course, bond yields fall as interest rates rise, and selling bonds as rates rise locks in losses. Because of this, bond managers continually buy and sell bonds as a means of maintaining the average maturity of the fund over time.
The financial takeaway
While finding good returns when interest rates is challenging, viable fixed-income investments do exist. Online savings accounts, CDs, and bonds are all options.
Bonds as a class are considered conservative and suitable for fixed-income portfolios. Whether individual bonds or bond funds, debt securities generally offer higher yields than many other fixed-income vehicles, like bank accounts and CDs. Of course, the greater the return, the greater the risk. That's the cardinal rule of investing, in any climate.But when interest rates are low, fixed-income investors must be open to loosening up their risk tolerance. At least, until interest rates start to rise again.
Related Coverage in Investing:
Bonds vs. CDs: The key differences and how to decide which income-producing option is better for you
ETNs combine a bond's reliability with a stock's profitability. Here's how they work, and how to weigh the risks and rewards
- Karnataka budget 2021-22 to be presented on March 8
- Delhi Budget likely to have special allocation for free COVID vaccination at govt hospitals: Sources
- Future iPhones may arrive with Smart Magnetic Connectors, says report
- Centre proposes to raise LIC's authorised capital to ₹25,000 crore
- Huawei files two patents related to electric vehicles, says new report