What to Do About Low Interest Rates

It’s official: rates on certificates of deposit have never been lower, according to last week’s interest rate roundup by Bankrate.com. The average rate on a 1-year CD is 0.34%; on a 5-year CD, 1.14%.

Even worse, those rates are below the prevailing rate of inflation, which has been running at about 3%. That means if you walk into a bank today and buy a CD, the real interest rate on it will be negative.

“Unfortunately, Ben Bernanke’s not throwing any bones,” says Bankrate senior analyst Greg McBride. “The Fed intends to keep interest rates low for the next couple of years.”

Low interest rates probably aren’t news to anyone at this point—not even 8-year-olds. My daughter opened a savings account at a local bank through her school, and while she enjoys hobnobbing with the nattily-suited bank employees who come to school every Wednesday, her account pays 0.1% interest. At that rate—ignoring inflation—she can double her money in 700 years.

But I’m a silver lining kind of guy. Heck, these days, I would settle for a tin lining. Say you’re saving for an expense coming up in the next couple of years, and you are not, personally, the chairman of the Federal Reserve, nor do you want to put your money at risk by investing in stocks. What can you do about low interest rates?

Shop around

My daughter’s bank account, in turns out, is exactly average among savings accounts in the US. (You can, in fact, do worse than 0.1%: I have seen a savings account at a major bank paying 0.01%.) But the best savings accounts pay a lot more than that: up to 0.9% at online banks like Ally Bank or EverBank (both Mint.com partners). “Now, 0.85% isn’t going to blow anybody’s hair back,” says McBride, “but look at it this way: you’re earning 8-1/2 times as much interest on that account by shopping around.”

That 0.85%, is, in fact, better than a lot of 1- and 2-year CDs. If there’s a chance you might need the money in less than a year, the last thing you want to do is have it locked up in a CD. “The penalty could leave you worse off than you would have been if you had chosen either a shorter-term CD or a savings account,” says McBride.

Once you buy a CD, you lock in a rate for the term of the CD. That’s great if rates continue to go down, but if they go up, you’re stuck waiting or paying the penalty to break the CD and reinvest the money at a higher rate. So it makes sense to look for CDs with a low early withdrawal penalty (Ally’s is the lowest, at 2 months interest). Also, some banks offer “bump” or “raise your rate” CDs that let you reset your interest rate once or twice during the term of the CD. Of course, you’ll pay for the privilege.

With a savings account, however, your money is never locked up, and when interest rates go up in general, so will the rate on your savings account. “The accounts that are the top payers now are also most likely to be the top payers in a rising rate environment,” says McBride.

Use the bank of Uncle Sam

The US Treasury does little to promote savings bonds, so I try to do my part. (If Tim Geithner sends me a statue of liberty costume, I will stand out on the street corner promoting savings bonds.) Series I savings bonds (I-bonds) are similar to CDs, but you buy them directly from the government at TreasuryDirect.gov. They’re guaranteed to keep up with inflation; the I-bonds I bought last May earned 3.83% over the last year, better than any CD.

Of course, every silver lining has a touch of grey, and I-bonds have some downsides, too. You can’t cash them in during the first year, period, and if you cash them in within 5 years, you pay a penalty of 3 months interest. Each person can buy a maximum $10,000 worth of I-bonds per year.

In the past, I’ve poked fun at the TreasuryDirect site for its byzantine, Berlin Wall-inspired security measures. Recently they’ve made it a little easier. It’s still trickier than logging into Facebook, but worth it.

Watch out for risky business

When interest rates are low, salesjerks and outright scammers crawl out from their holes promising high interest rates with no risk. In 2012, there’s no such thing as high rates with no risk. Watch out for these common pests:

Dividend stocks. There’s nothing wrong with dividend stocks as part of a diversified portfolio, but they’re not a substitute for a savings account or CD. A high-yielding stock or fund can plummet in value just when you need the money.

Structured or linked CDs. These are FDIC-insured CDs tied to a commodity or currency or stock market index. The pitch is always the same: if the market goes up, you win; if the market goes down, you get all your principal back. They’re always designed to tantalize you with the prospect of a high return while using a complicated formula to pay you less than an old-fashioned CD.

Foreign currency CDs. I keep hearing about CDs in India or Australia paying 5% or better. But this is only a good idea if (a) you trust the foreign country’s deposit insurance, and (b) you intend to spend the money in rupees or Australian dollars. Otherwise, you’re taking currency risk, and exchange rates can move fast.

Count your blessings

Here’s how I lull myself to sleep at night even though my savings account is paying 0.7%. We live in a society where we can put our money in the bank and be confident that we can go in tomorrow, or next week, or next year, and get all of it back out without having to hear a sob story from Jimmy Stewart.

We’re still trying to recover from the worst financial crisis in 80 years. Hundreds of banks have failed. How much money did depositors lose in their savings and checking accounts and CDs? Zero. Nor have we been wiped out out by Zimbabwe-style hyperinflation.

That level of safety and resiliency is pretty incredible by historical standards. Getting paid a little interest on top is gravy.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.