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SJan 4, 2013

Coping with the Zero-Interest-Rate-Policy

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 “You don’t need to tell me that interest rates are low and that retirees are getting a bum deal. What I need you to tell me is what to do about it. I need a decent income from my savings.”

That’s the thumbnail summary of what readers have said about my columns on the difficulty the Federal Reserve Zero Interest Rate Policy is causing. In fact, the menu of safe (or relatively safe) responses to pathetic rates on CDs and other safe investments is painfully short, but here’s my list of good tools:

Debt Is the New Thrift.

If you owe money you’ll find more opportunity in refinancing or paying down debt than in finding yield on your savings. This would be irrelevant for retirees and near-retirees if no one had any debt. But the reality is that debt has been increasing among older people. So this may be a big-time opportunity.

Let’s start with the obvious: credit cards. If you run a $2,000 balance on your credit cards and pay 18 percent a year the annual cost is $360. With the highest yielding one year CDs on Bankrate.com yielding about 1 percent, you’d need $36,000 in CDs to produce that $360 in interest income.

After that, refinance your car. As I pointed out during the summer, many credit unions now do 5-year loans on used cars at about 2 percent interest. So if you’ve got a loan at 4, 5, or 6 percent, you may save as much in interest as you could earn on the same amount in savings.

And if you have a home mortgage, start looking at opportunities to refinance at rates lower than 4 percent. Also, don’t forget that refinancing can reduce your income need as well as the current interest you pay. Here’s an example. Suppose you have 10 years left to pay on a mortgage with a $100,000 balance at 5 percent. That mortgage would be costing you $1,061 a month. If you refinance it to a new 30-year mortgage at 3.5 percent, your payment will drop to $449 a month. Only about $125 of the $612 a month payment reduction will be reduced interest cost. The remainder will come from extending the period of the loan.

Does it matter? Yes, because your debt will last longer. But you’ll also have a much easier time getting through the month. Your cash flow will have changed dramatically. Put it this way, you’d have to have over $700,000 in one-year CDs at 1 percent to produce that kind of change in your income.

You can extend the same principle: Use no-yield savings to pay off an old mortgage. The old $100,000 mortgage above, for instance, has an out-of-pocket cost of $12,732 a year, a mixture of interest (about $5,000) and principal (about $7,700). Using $100,000 of no-yield savings will make a dramatic change in your monthly budget. It will feel like getting a 12.7 percent return.

Spending Smart Is Better Than Saving Dumb.

Low yields also make good buying decisions immensely more valuable. If you take a close look at every dime you spend, you’re likely to find expenses that can be cut. Do you really need or want all the cable TV channels you get? Have you minimized your bank account expenses? Have you thought about using the public library rather than buying books? Could you buy more, at lower prices through Amazon? If you save only $100 a month from more attention to spending, a person in the 15 percent tax bracket is eliminating the need to earn $117.65 from their savings, or $1,411.76 a year. You’d need $141,176 in a one year CD at 1 percent to produce the same interest income. Even in the long lost wonder days of 5 percent CD yields you would need to have over $28,000 in a CD to have an effect equal to $100 of smarter spending.

Dare To Invest In Equities.

When you have exhausted refinancing and smart spending you will have exhausted the no risk options. Then, the best step is to begin investing in a broad index fund. SPY, the SPDR S&P 500 index exchange traded fund, provided a yield of 2 percent during 2012. That’s more than the yield on a 10-year Treasury.

And by the way, the index also appreciated about 12 percent during the year.

Filed Under: Income Investing