Make Your Money Work Harder!
Is your bank offering competitive rates which beat inflation and taxes? If not, you may be able to earn a better rate & make your money work harder by shopping around.
The following table lists currently available rates for savings accounts, money market accounts and CDs.
The Impact of the Financial Crisis on Interest Income
The economic crisis which swept across the global economy in 2008 & 2009 created dire economic conditions which led to central bankers dropping interest rates close to zero (or even below it in some areas) and engaging in quantitative easing to stimulate the economy. On December 16, 2008 the Federal Open Market Committee set the official Fed Funds rate at 0.0% to 0.25%.
Commercial banks followed the central banks lower, dropping rates paid on savings, checking & money market accounts close to zero. In many cases fees were also added to formerly free account features, requiring a set minimum balance to bypass fees. Some accounts even started charging “analysis fees” for inbound deposits. One of the biggest US banks went so far as creating millions of fake customer accounts to hit internal growth targets. Many such accounts were opened without the consumer’s consent & had junk fees charged against them for not meeting minimum balance requirements or being inactive.
Asset prices have in many cases doubled or tripled from the 2009 lows. Unemployment across the United States has fallen below 4%. The Federal Reserve has lifted rates a half-dozen times as the recovery had seem to have become self-sustaining.
Gradual quarter-point increases reversed on July 31, 2019 when the FOMC lowered the Fed Funds Rate by a quarter of a percent. The trade war between the United States and China coupled with other issues like weakness in Europe and October 31st Brexit deadline caused the Federal Reserve to lower rates and end their balance sheet run off immediately at $3.8 trillion from a high of $4.5 trillion. Their balance sheet was around $800 billion before the 2008 crisis.
|Date||Fed Funds Rate||Discount Rate||Vote|
|December 16, 2015||0.25% – 0.50%||1.00%||10-0|
|December 14, 2016||0.50% – 0.75%||1.25%||10-0|
|March 15, 2017||0.75% – 1.00%||1.50%||9-1|
|June 14, 2017||1.00% – 1.25%||1.75%||8-1|
|December 13, 2017||1.25% – 1.50%||2.00%||7-2|
|March 21, 2018||1.50% – 1.75%||2.25%||8-0|
|June 13, 2018||1.75% – 2.00%||2.50%||8-0|
|September 26, 2018||2.00% – 2.25%||2.75%||9-0|
|December 19, 2018||2.25% – 2.50%||3.00%||9-0|
|July 31, 2019||2.00% – 2.25%||2.75%||8-2|
|September 18, 2019||1.75% – 2.00%||2.50%||7-3|
|October 30, 2019||1.50% – 1.75%||2.25%||8-2|
|March 3, 2020 *||1.00% – 1.25%||1.75%||10-0|
|March 15, 2020 * +||0.00% – 0.25%||0.25%||9-1|
- * surprise rate cuts to combat the economic impacts of the global coronavirus outbreak
- + also announced a new round of quantitative easing, promising to purchase at least a half-trillion dollars worth of Treasuries and $200 billion in mortgage-backed securities
In spite of the Federal Open Market Committee rate hikes most banks pay a small fraction of a percent interest on savings or checking accounts. Some of those same banks will pay much higher rates if you look at their ads & open a new account. Some regional banks which have struggled to grow deposits have been sending mailers with $300 bonus offers to people who open new checking accounts.
If possible, banks would like to accumulate deposits without increasing the cost basis of the current deposits they hold. In mid-2018 banks began raising interest rates on ordinary savings accounts, though they still remain a fraction of a percent in spite of reaching 5-year highs. According to the Wall Street Journal the shift toward bonuses offers banks higher returns due to targeting new customers who are likely to stick around:
growth in deposits has slowed, which threatens an important source of low-cost funding for banks in recent years. When the Fed raised interest rates in the past, banks raised rates paid to depositors to keep them around. This time around, banks have passed along only 18% of the benefit from higher rates to customers, according to Erika Najarian, a bank analyst at Bank of America Corp.
Banks increasingly prefer the bonuses to raising rates broadly because they allow them to specifically target people who open a new primary bank account. A recurring direct deposit or minimum balance is typically required to earn the bonus, making it hard to earn the bonus on a secondary account.
Like savings accounts, CDs are insured by the FDIC. CD rates are somewhat competitive against bonds in the 1 to 2 year time-frame, but for shorter durations treasury bills typically offer higher yields.
Where to Buy
One solution for savers who wish to bypass the volatility of the financial markets & earn a higher return than their bank offers is to buy U.S. Treasury bonds, bills & notes directly at TreasuryDirect.gov.
Setting up an account only takes a few minutes. An order can be inserted in a few minutes where they’ll withdraw funds from your bank account to fund a purchase in an upcoming auction. Interest earnings & principal can be deposited back to your bank account or automatically reinvested.
Many federal bonds are exempt from state & local taxes, while being a taxable event at the Federal level. Some are also exempt from Federal taxation if the interest income is used to pay for educational expenses.
There are many flexible options to choose from. The following table offers a brief overview.
|Type||Description||Example Use Case|
|Treasury Bills||Short-term government securities which range from a few days up to 52 weeks. These are sold at a discount to face value.||Earn interest while staying liquid, enabling you to cash out quickly to meet cash-flow demands or to reinvest earning higher rates if rates rise in the future.|
|Treasury Notes||Government securities issues with the following maturities: 2, 3, 5, 7 & 10 years. These pay interest every 6 months.||Earn interest throughout various durations to build a ladder which matches maturation with income needs over time.|
|Treasury Bonds||Government securities which mature in 30 years. These pay interest every 6 months.||Longterm financial planning & added stability to a volatile investment portfolio.|
|Treasury Inflation-Protected Securities (TIPS)||Marketable securities which adjust the principal in accordance with changes to the Consumer Price Index. These are issued with the following maturities: 5, 10 & 30 years. They pay a fixed rate of interest every 6 months, which adjusts based upon monthly CPI-U data.||Offers inflation protection & can be sold at any time into the secondary market.|
|Floating Rate Notes (FRNs)||Issued in 2 year terms & pay interest quarterly based upon the discount rates for 13-week Treasury bills.||Earn interest for up to 2 years at a rate which adjusts with changing short-term rates.|
|I Savings Bonds||Interest accrues over the life of the bond for up to thirty years. Interest rate adjusts twice annually based on May & November CPI-U data. Interest can either be paid annually or paid upon redemption, at which point it is a taxable event. Electronic purchase limit is set to $10,000 per year per SSN. Not a marketable security. Can’t be sold into the secondary market.||Earn interest which adjusts with inflation & goes untaxed until redemption, final maturity or other taxable disposition.|
|EE & E Savings Bonds||Low-risk savings products which pay interest for up to 30 years. Electronic EE bonds are sold at face value. Interest accrues at a fixed rate for the duration of the bond & is added monthly to the bond until cashed.||Earn a fixed-rate of interest for up to 30 years.|
Comparing Yields Across Various Durations
The following table shows example yields for various federal government bond options, high-yield savings accounts & certificates of deposit.
For sake of simplicity, CDs & bonds with fixed-interest rates are shown. Some CDs may have step up features where yields change over time & some bonds come with inflation protection aspects which lower initial yields in exchange for protecting the investor’s purchasing power if inflation jumps significantly. Listing the options with variable rates would make it harder to quickly compare like with like based upon duration.
You can see yields from recent government auctions here.
|Investment Type||Duration||Issued||Maturity||Recent Yield||Type||Equivalent Annual Earnings on $10,000|
|Default Checking or Savings Account||0.010%||variable||$1.00|
|High-yield Savings Account||1.900%||variable||$190.00|
|Treasury Bills||4 weeks||06/07/2018||07/05/2018||1.780%||fixed||$178.00|
|Treasury Bills||13 weeks||06/07/2018||09/06/2018||1.910%||fixed||$191.00|
|Treasury Bills||26 weeks||06/07/2018||12/06/2018||2.070%||fixed||$207.00|
|Treasury Bills||52 weeks||05/24/2018||05/23/2019||2.275%||fixed||$227.50|
|Treasury Notes||2 years||05/31/2018||05/31/2020||2.500%||fixed||$250.00|
|Treasury Notes||3 years||05/15/2018||05/15/2021||2.625%||fixed||$262.50|
|Treasury Notes||5 years||05/31/2018||05/31/2023||2.750%||fixed||$275.00|
|Treasury Notes||7 years||05/31/2018||05/31/2025||2.875%||fixed||$287.50|
|Treasury Notes||10 years||05/15/2018||05/15/2028||2.875%||fixed||$287.50|
|Treasury Bonds||30 years||05/15/2018||05/15/2048||3.125%||fixed||$312.50|
If you are uncertain of your future cash needs you can buy bonds of different durations to where you have a lower yielding set of bonds that matures in the near future & then higher yielding bonds which regularly mature every year or two over time. Breaking your investment into chunks enables you to maintain a fairly steady cash-flow while allowing you to reinvest periodically to take advantage of market shifts.
Most bond investors prefer to have the majority of their bond investments in safe government securities. A barbell approach augments the core low-risk holdings with a smaller position of higher yielding and higher risk bonds or other bond-like investments.
TLT is the ticker symbol for iShares 20+ Year Treasury Bond ETF, a well-known low-risk government bond fund which yielded about 2.75% in late December of 2018..
JNK is the ticker symbol for SPDR Barclays Capital High Yield Bond ETF, a well-known high-yield bond fund which yielded about 6% in late December of 2018.
Depending on market conditions, the spread between higher-quality & lower-quality may narrow or widen. In bull markets credit spreads often narrow as there is a bid under everything, whereas in bear markets the yield spread blows out.
Borrowers with investment-grade debt ratings (essentially higher credit scores) are paying more than 1.4 percentage points above Treasurys to borrow, up from less than 1 percentage point at the start of the year.
Spreads on junk bonds, issued by companies that are considered significantly less creditworthy, have risen even more, from around 3.2 percentage points at the start of the year to more than 4.5 percentage points now, according to FactSet.
People who intend to save for the long haul may consider high-dividend stocks as a viable option to augment their bond holdings, particularly in times when bonds have low yields.
In June of 2018 telecommunications stocks like Verizon & AT&T offered dividend yields of around 5% to 6%. Those numbers compare favorably with Treasury Bond yields around 3%. If the holder does not need to liquidate the positions for an extended period of time then high-quality equities will typically outperform bonds. But if the holder needs to sell the security and the price declines then it is not uncommon for some dividend stocks to lose multiple years worth of dividends in capital value when markets slide. As of December 2018 AT&T had a 52-week high of $39.32 per share with a Christmas-eve close of $27.36. At the current yield of 7.46% it would take over 4 years to offset the 27.7% decline in capital value at current yields.
When Treasury Bond yields increase the share prices of utility, telecommunications & energy companies typically fall as they are not as attractive on a relative basis when Treasury rates were lower. When investors consider safe bond yields reasonable they pull back from the risk curve.
Some companies may cut dividends during times of distress, but most high-dividend stocks consider the dividend vital to retaining investor support for the company. The stock prices on some dividend stocks can fluctuate 10% or more per year, but if you know you will hold the stock for an extended period of time & the probability of the dividend going away is quite low then it can make sense to leverage high-dividend value stocks for a portion of your barbell. Another advantage of holding longterm dividend stocks is qualified dividends are taxed at lower rates than ordinary income. The following table applies to tax year 2018.
|Qualified Dividend & Cap Gain Tax Rate||Single Filer||Joint Filer||Head of Household|
|0%||$0 – $38,600||$0 – $77,200||$0 – $51,700|
|15%||$38,601 – $425,800||$77,201 – $479,000||$51,701 – $452,400|
Individuals or heads of household who earn over $200,000 are also obligated to pay the 3.8% net investment income tax. Married filing jointly are required to pay NIIT if they earn above $250,000, while married filing separately are required to pay NIIT if they make over $125,000.
Municipal Bond Funds & Trusts
Some municipal bond funds offer tax-advantages, which increase their effective yield when compared against other bonds which are taxed as ordinary income. Here is a table listing a few municipal bond funds along with their recent performance as of December 24, 2018.
|Fund Name||Ticker||Capitalization||Price||Yield||52-week range|
|Blackrock Muniyield Fund||MYD||$591 million||$12.67||5.59%||$12.29 – $14.77|
|Invesco Value Municipal Income Trust||IIM||$630 million||$13.37||5.33%||$13.09 – $14.96|
|Nuveen AMT-Free Municipal Credit Income||NVG||$2.77 billion||$13.64||5.76%||$13.30 – $15.67|
|Nuveen Dividend Advantage Municipal Fund||NAD||$2.54 billion||$12.56||5.11%||$12.24 – $14.11|
|Invesco Trust for Invstment Grade Municipal||VGM||$616 million||$11.37||5.44%||$11.20 – $13.32|
|Invesco Municipal Opportunity Trust||VMO||$750 million||$11.13||6.01%||$10.89 – $12.51|
|Invesco Municipal Trust||VKQ||$615 million||$11.12||5.69%||$10.87 – $12.67|
|Invesco Advantage Municipal Income Trust II||VKI||$446 million||$10.03||5.98%||$9.96 – $11.49|
|Invesco Quality Municipal Income Trust||IQI||$593 million||$11.22||5.70%||$11.03 – $12.55|
|MFS Municipal Income Trust||MFM||$256 million||$6.20||5.68%||$6.04 – $6.95|
|Deutsche Strategic Municipal Income Trust||KSM||$114 million||$10.18||5.84%||$10.03 – $11.91|
|Invesco Municipal Income Opportunity||OIA||$332 million||$7.00||5.57%||$6.94 – $8.25|
Three things to be aware of with bond funds:
- Close ended funds might be highly illiquid, having outsized shifts in market turbulence. However you do not lock in losses if you hold the fund until it recovers in value.
- Open-ended funds might have more liquidity, however when other holders sell their stakes the underlying fund manager may be forced to sell securities at market, locking in losses for other investors who still hold a position in the security.
- Bonds typically have lower longterm returns than equities do, which makes ensuring funds have a low management fee important to achieving reasonable returns.