3 Alternatives to Low-Yielding CDs


NEW YORK (MainStreet)—Certificates of Deposit--commonly known as "CDs"--aren't paying much these days. According to Bloomberg, a 1 year CD pays slightly over 0.5%; if you tie your money up for five years, don't expect more than a 1.26% return.

How can you make your money work harder for you? You could turn to the stock market, but there's risk, like the 25% drop in stocks that we saw at the end of 2008. For many, the risks of a stock-only portfolio are just too great. But there are alternatives out there in the bond market that retirees can use to get a passive income stream beyond today's low CD rates.

Individual Savings Bonds (iBonds)

iBonds, as they have come to be known, are simple and low-risk savings bonds that typically offer a low interest rate and a low risk of losing principal. In fact, the only way you can lose money on an iBond is if the United States government defaults on its debt. Because they are so low risk, the interest rate they offer is negligible: all bonds issued between May 1, 2013 and October 31, 2013 is 1.18%.

"These are not for 'investing' per se," says Marshal Kofler, deputy director of the U.S. Department of the Treasury Financial Management Service. Instead, savers can choose to buy iBonds as a way to save money for a fixed period of time. iBonds can be bought directly from the U.S. government without a broker, and they can even be purchased online.

Interest payments are taxable, and there is a penalty if you redeem an iBond if you do not hold it for five years or more. This penalty will equal the last three months of interest payments, which are forfeited in cases of early redemption.

Treasury Inflation-Protected Securities (TIPS)

TIPS are investments that go up in value at exactly the rate of inflation as calculated by the Consumer Price Index. Much like bonds, TIPS can be purchased for a fixed duration, with terms of 5, 10 and 30 years available.

While TIPS will go up at the rate of inflation, there is also a risk that they will go down in value in periods of deflation. Likewise, they will tend to underperform other asset classes in periods of low inflation or deflation, which typically favor bonds, meaning that TIPS are not entirely risk free.

"As with any marketable security there are risks involved in buying them depending on ones plans and investment portfolio," says Kofler, who recommends talking with a commercial broker or dealer before investing in these assets.

Municipal Bonds

Municipal bonds are loans given to a local government somewhere in the United States. Similar to iBonds, investors lend a fixed amount of money to a smaller government agency and are paid interest on that loan at set intervals.

Municipal bonds have remained relatively safe investments for a while, says Terry O'Grady, head municipal bond trader of FMSBonds, Inc.

"The level of defaults is minuscule, and the recovery level of those few municipals that do go through default is very high," O'Grady says. "The risk of losing money due to default in a diversified municipal bond portfolio is negligible."

While the risk of losing capital is very low, municipal bonds carry another risk related to interest rates. "If interest rates rise, the value of a municipal bond will go down," O'Grady explains. "If you don't plan on selling your bond before it comes to maturity, this isn't a big deal, but it can be an issue if you want to resell your bond beforehand."

Reselling is always an option. "Muni bonds are liquid," O'Grady says. "Any day, any time a customer wants to sell a bond, they can call us up and we can put on the order in a second."

--Written by Michael Foster for MainStreet

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