Help! My Cash is Earning Almost Nothing: What are My Options for Better Returns?
Several decades ago, many investors kept a significant part of their savings in cash - typically in FDIC guaranteed bank accounts. Why? It’s was a safe and easy choice. They might have been keeping their powder dry for other opportunities in the market or in real estate or just wanting to earn some interest without volatility. Back then, waiting didn't hurt because bank account interest and money-market rates were considerably higher. Savers were getting paid well to wait.
Unfortunately, this is no longer the case and hasn't been true for quite some time. Money markets and CD's earn near zero, not only frustrating the patient investor, but also wreaking havoc on the retirement income of those who used to depend on higher interest rates to support their lifestyle. Right now, keeping money in the bank or in money market funds is almost like earning a negative return because prices of most living expenses are rising faster than the rates earned on cash. Many are bothered by these low returns but are unsure how to do better. Read on below as we cover alternatives to cash that savers can use to immediately start earning better returns.
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Interest Rates and Markets From the Early 1980’s to Present Day: A Synopsis
Before we turn to some potential options to earn higher returns, let’s review four decades of interest-rates and their trends over time. This background will help to add context to the problem of low returns on savings that many investors are facing today.
Though it seems like a distant memory today, back in the early 1980’s, the effective Fed Funds Rate, to which money market and CD rates are typically tied, were unusually high, sustaining in the high teens and at one point spiking to around 20%. Since then, short-term interest rates have dropped steadily, staying below 10% since the mid 1980s and staying below, often well below 5%, since 2009. In fact, for the years 2010 to 2015, the rate hovered just above zero. Of late, the rate has turned a bit higher, but not by much, offering a paltry 2.04% as of October 2019.
The U.S. Federal Reserve manages short-term interest rates. These rates are highly sensitive to the Fed’s perception of what is happening in the U.S. and global economy. So what was going on since the early 1980’s that has driven rates for savers to such low levels today?
In 1973, the U.S. dollar was disengaged from the gold standard. This was the beginning of an inflationary period that lasted for the remainder of the 1970’s. In order to fight inflation, the FED resorted to raising short-term interest rates. The rate hikes eventually created a recession in 1980. Nevertheless, investors in cash proxies were handsomely rewarded with the very high yields of that time.
The ongoing interest-rate decline since 2009 was largely caused by the Financial Crisis of 2007-2009. This event was considered by many to be the worst financial collapse since the Great Depression of the 1930’s. It began as the subprime-mortgage market in the U.S. began to unravel. That was the catalyst that developed into a full-blown global financial meltdown. There was fear of an overall collapse in the global financial system. To combat that possibility, central banks around the globe took coordinated actions to lower interest rates and add liquidity to the global financial system in the hope of stimulating national economies to bounce back and start to mend the financial system. Sluggish global growth since then has kept rates abnormally low. In fact, in some countries, short-term interest rates are currently negative. This means that in quite a few countries, bank accounts and bonds actually give you back less money than you deposited or invested at the start.
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Back to the Current Investor’s Dilemma
That brief history may be informative as to how we got to today’s low-interest-rate environment, but what are retirees and other investors to do. The reward for parking large amounts of cash is now dismal and in many places actually negative. Furthermore, for many retirees, who used to depend on returns from money markets and CD’s for a significant portion of their spendable income, the last few years have been a disaster.
Fortunately, there are a number of options available. Unfortunately, very few of these options are as risk-free as cash. In today’s environment, seeking higher income often means investing in securities that can fluctuate in value. In this environment, investors have to be more sophisticated and savvy. They have to have the ability to compare complex alternatives, do careful research on each options pros and cons and then make calculated moves to capture more value on their savings. Let’s investigate some of these options.
Return-boosting Options: The Good, the Bad and the Ugly
These days, many investors are reaching for higher-yielding investments in place of the safety of money market funds and bank CD’s, where their principal was protected. Instead, they are looking, among other things, to real estate investment trusts (REITS), high-yield and dividend paying stocks, intermediate- to long-term bonds or bond funds, master limited partnerships (MLP’s) and closed-end funds. Although these generally provide a higher yield, they also come with risks not associated with cash equivalents.
REITs are investment pools that collect rents from their real-estate holdings and are required by law to pass on at least 90% of their profits to their shareholders in the form or regular distributions. Many of these yield between 3% and 7% and generally pay their dividends quarterly, although some also pay monthly. They may be an important part of many investors’ total portfolio but are not without risk. Chief among these is that they can decline in value. For higher net worth and accredited investors, the option to invest directly in private income producing buildings is also available. The benefits of investing directly in commercial real estate include better tax advantages and higher distributions but with the downside of lower liquidity on the investment. At Ridgewood Investments, we are quite active in both areas of real estate investing and we are still finding good opportunities in both areas for long-term investors.
Intermediate- and long-term bonds deliver yields that are higher than cash-equivalent income securities. These days, however, longer-term U.S. Treasury bonds do not pay much more than cash equivalents perhaps about 1% or so. They also come with a potential problem: Their value will decline if interest rates rise. Of course there are many other types of bonds to consider, such as municipal bonds and corporate bonds. All are subject to interest rate risk so understanding the underlying credit characteristics of the bonds you invest in is quite important.
Stocks in general and dividend paying stocks in particular are another great alternative for long-term investors seeking higher returns. During the entire post financial crisis period characterized by very low interest rates, stocks and especially US stocks have actually generated excellent returns. Unfortunately, many people were scared out of the market by the last financial crisis and many of them never really got back in so they missed out on this last decade or so of great returns. In fact, US stock markets have been making new highs these past few years. Investors still sitting with a lot of cash may be unsure of how to proceed. They may feel that they have missed out and it is too late to do anything about it. However, the stock market always offers some great opportunities to investors who can take a long-term view and have a sound strategy based on solid principles like value investing and doing their homework.
Within the stock market, one area of particular interest may be dividend paying stocks including high-yield stocks, such as many electric utilities and telecommunication firms. These firms can offer yields in the 3% to 6% range plus a little growth on top of that over time. Again, like REITs and bonds, they can decline in value so you have to be careful. Some high-yield stocks, such as tobacco companies, have some inherent legal risks that can also negatively affect their prices. Within the area of dividend stocks, another way to identify good opportunities is to look for companies that have average or even below average current dividend yields, but that are expected to grow their dividends consistently for many years to come. These "dividend growth" companies can be good for earning higher income and greater total returns - again for long-term investors. At Ridgewood Investments, we have an entire team dedicated to finding great dividend growth investing opportunities.
One caveat in all of the above areas is to watch out for unsustainably high yields. High yielding securities can be value traps offering "sucker yields" and may have additional idiosyncrasies that add further risks to their total return potential. Chasing a high yield only to find it cut after you make the investment can be a recipe for disaster. Before you make any investment commitment to improve your returns, make sure you do thorough research to consult or hire the expertise needed to make good investment decisions in these and other areas.
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One step can bring you a lifetime of benefits.
An Experienced Advisor Can Be Invaluable in this Low Interest Rate Environment
As you can see, it’s not the early-1980’s interest-rate environment anymore with its lucrative alternatives for savers. Many folks sitting on large amounts of cash today may feel they may have missed this current bull run or feel unsure about what to do.
In times like this, you may wish to partner with a trustworthy advisor, especially when you review the risks associated with reaching for higher yields. At Ridgewood Investments, we help long-term investors including those sitting on large amounts of cash earning low returns.
If you are wondering what to do, help is only a call or email away. Let us help you navigate the choppy investment waters of the current low-interest-rate environment and steer the ship of your investment portfolio to a better returning port.
About the Author
Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.
Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.