Coping in a Low Yield Environment

Yields, especially on bank CDs and money market instruments have hovered at low levels for a really long time.  In addition, yields on bonds are also low, making people who count on or benefit from interest income rather worried.  A low yield environment (engineered by monetary authorities) is used to encourage people to take more risk and shift their funds from bank accounts and CDs in a search for higher yielding and higher risk investments.  While searching for more yield is a good aim, this is generally the time in the business and investment cycle when higher risk instruments run up in price.  Here’s what I would recommend:

–Be sure your cash holdings are all earning reasonable interest — I think that most people should still keep their emergency fund and funds they might need to access in investments that do not have significant risk of loss of principal.  However, within this group, yield can be maximized by keeping minimum balances in places that have zero or near-zero yield (like a checking account), and by shifting your savings to accounts that bear a higher rate of interest.  I keep my emergency fund at ING Direct.  While the 1.1% per annum interest sounds paltry, it’s better than 0.05% at my other bank. Be sure that you do not inadvertently incur fees with any shifts.

–Explore higher yielding investments — at present some of my favorite include high dividend ETFs (such as SDY and IDV) and also a small percent into high yield areas like high yield corporate bonds. Keep in mind that risk premiums on these instruments have come down considerably.

–Learn about other areas that are not experiencing low yields — For example Australia is a high yield area, and Canadian interest rates are not moving lockstep with the US.

–Be wary of rising yields — with US interest rates at their low point, the only direction for the Federal Reserve to take them is up, although the timing may not be clear.  In a rising interest rate environment, be aware of what investments tend to perform poorly, such as high quality bonds.  In fact, many of these have already shown price declines in the past few weeks.

shared at this week’s Carnival of Personal Finance