Getting the Best Investment Yield Without a Lot of Risk

Sep 7, 2011 by Laura Brewer

Dear Laura,

I am a fairly conservative investor. Over the years, I have accumulated a number of certificates of deposit (CDs). A couple of years ago, as my CDs came due I was able to roll them over into new CDs with attractive interest rates—about 4 or 5% for 1 – 3 years. Now, however, as my CDs come due, I am looking around for more CDs to purchase and simply cannot find any that offer a meaningful amount of interest. Am I looking in the wrong places? Or, are CD rates just super-low right now? Do you have any suggestions as to what I can do with my money to earn a return without exposing myself to a lot of risk?

Searching for yield……….Mariel

Dear Mariel,

I can empathize with your dilemma!  At least once a week, if not more often, I speak with clients who ask me the same question.  The yields on CDs (as well as a number of other fixed-rate instruments) are quite low right now because the interest rates set by the Federal Reserve are at historically low levels. 

Background: The Federal Reserve is tasked with devising and implementing sound monetary policy that hopefully helps keep the US economy healthy.  In an ideal world, the Federal Reserve is able to set a monetary policy that enables the US economy to grow at a reasonable and steady pace over time and does not encourage or foment unpleasantly high inflation.

The Federal Reserve implements monetary policy by managing the country’s money supply and access to credit.  One tool it has in its arsenal is the ability to set several key interest rates—the federal funds rate and the discount rate.  When the Federal Reserve wants to encourage economic activity it lowers these interest rates, thereby making money cheaper to borrow.  Conversely, when the Federal Reserve wants to dampen economic activity—usually because inflation is too high and the economy is overheating—then it raises these interest rates.  Because the US economy entered a recession in 2007, the Federal Reserve then embarked upon a highly accommodative monetary policy designed to increase economic activity and prevent the US economy from falling into a deeper recession or even depression.

At present, the target federal funds rate—this is the rate banks charge each other for overnight loans—is 0 – 0.25%.  The discount rate—the rate Federal Reserve banks charge other banks for short terms loans—is 0.75%.  A number of other key consumer interest rates, including mortgage rates, credit card interest rates, CD rates, and money markets rates, key off of these two important rates.  Thus, when the Federal Reserve lowers the federal funds rate and/or the discount rate, this generally means consumer interest rates fall as well.  The opposite is also true—as the Federal Reserve increases rates, consumer rates raise as well.

Back to your question: A low interest rate environment, such as the one we are in right now, is great for those who need to borrow money but not great for those who need to earn some interest on their money.  Accordingly, investors who are in search of yield may need to be a bit more creative.  Depending upon your risk tolerance level, your overall asset allocation mix, and your financial needs, it may be appropriate for you to consider one or more of the following strategies to increase yield:

1. High quality “blue chip” equities with a history of paying dividends to shareholders
2. Fixed-income focused exchange-traded funds (ETFs) or closed-end funds
3. Master limited partnerships (MLPs)
4. Real estate investment trusts (REITs)
5. Preferred equity shares

Before you embark upon any course of action to replace the income you lost as your higher yielding CDs came due, you should consider meeting with your financial advisor. If you don’t have one, think about finding one, because some of the ideas mentioned above are riskier than others and some could complicate your tax situation.  Also, within each type of investment mentioned above, there are some outstanding options, but there are others that are average at best.  Your financial advisor could help you craft an investment plan that would replace some, if not all, of the income you lost as your CDs came due and may be able to do so without increasing your risk in a meaningful way.

Speaking of risk, it is also important to keep in mind that in the investing arena there is a relationship between risk and reward.  Generally, the more risk you take, the more potential reward you could expect to receive.  This same premise holds true as you look for more yield. Thus, you can expect the highest of investment grade bonds to pay the least amount of yield and then for progressively lower quality bonds to offer investors increasing amounts of yield.   For example, bonds backed by the full faith and credit of the US government are considered to be some of the “safest” investments around.  The yields on government bonds generally are considerably lower than those earned on corporate bonds, particularly those rated below investment grade.  The “below investment grade” corporate bonds offer more yield because there is a greater risk the company issuing them will default on them than there is risk that the US government will default on its bonds.  In order to attract potential investors, issuers of lower quality bonds must compensate investors for their assumption of more risk by paying a higher return.

Good luck in your search for yield and remember that if you find an investment offering a “too good to be true” yield, proceed very cautiously…….

Yours in financial health,

Laura

Laura W. Brewer is Senior Vice President of Burke, Lawton, Brewer & Burke, LLC and a Portfolio Manager with BLB&B Advisors, LLC. Laura builds and manages investment portfolios for individuals, families, and small institutions and also assists her clients with a wide variety of financial planning matters including estate, education, and retirement planning. Read more about Laura Brewer