This retired couple needs more income from their IRA, but they can't afford to take any risk. What should they do?
If you’ve got a savings account, you can relate to this week’s question…
A retired couple in their late sixties. IRA money languishing in low-return CDs. And the return is moving toward zero due to the Fed’s relentless efforts to keep rates down. We want safety, but we need a decent return! What to do?
– Terry, Twin Cities, MN
Here’s your answer, Terry!
Unfortunately, when times are tough and unemployment high, Uncle Sam does what he can to help out. And one of the main things he can do? Keep interest rates low in hopes of getting us consumers to borrow and spend. Since consumer spending makes up two-thirds of our economy (business spending making up the rest), when we spend more, our factories produce more and, hopefully, hire more.
But while low rates are great for borrowers, they’re tough on savers. Especially those who depend on the interest from their savings to stay alive.
So what’s a saver to do?
I wish there were a magic bullet, Terry. I’d love to be able to tell you there are rock-solid ways to beat the banks without risk. Unfortunately, I can’t. Beating the interest rate on bank CDs is easy enough. But there’s no free lunch – you can’t do it without taking some degree of risk.
There are, however, ways to earn more with a manageable amount of risk. I do it, and so can you.
We’ve written about this a lot, most recently in 8 Ways to Earn More on Your Savings. You should read that entire post, but here’s a summary of those ideas:
1. Shop around
If you’re going to stick with insured savings, at least make sure you’re getting the highest possible. We have an online search for rates you can use to compare rates nationwide. But don’t end your search there. Smaller local banks and credit unions often have higher rates than the bigger banks that show up in these search engines, so check local deals too.
2. Invest in stocks
Investing in stocks is obviously riskier than putting money in an insured savings account, but the rewards can be much higher.
Stocks don’t pay interest, but some pay dividends, which amounts to the same thing. Find a good, solid company with a decent dividend, and you can earn multiples of what banks are paying and have some upside potential as well. For example, take a look at my online portfolio and you’ll see I own Conoco. If you bought it at the recent price of $56 a share, the $2.64 annual dividend would amount to 4.7 percent interest.
I bought Conoco a few years ago, when it was going for $31 a share. So on the price I paid, that same $2.64 dividend means I’m earning 8 percent. I’ve also got a gain on the stock of about 80 percent.
Granted, there’s obvious risk in this, or any, stock. But it’s a pretty safe bet that Conoco isn’t going out of business any time soon. It’s also highly unlikely the dividend will go down. Meanwhile, I’m not just beating the bank – I’m killing it. To learn more, check out How Dividend Stocks Can Help You Beat the Bank.
3. Mutual funds
One of the keys to investing on Wall Street is diversification: Spreading your money out over a group of stocks or bonds is safer than just buying one or two. That’s the idea behind mutual funds. With a mutual fund, your money is pooled with other investors’ and invested into a big basket of stocks, bonds, or both.
There are dozens of mutual funds available that invest in just about every kind of security, from government bonds to Chinese stocks. The risk in mutual funds obviously will coincide with the risk of the investments they hold. But a mutual fund is a good way to get a bunch of stocks for the price of one.
Bonds are basically IOUs from companies or federal and state government agencies. As with a bank CD, when you buy bonds, you’re loaning money and earning interest. You can either hold the bond until it matures or sell it on the open market prior to maturity for its then-current market price.
Bonds are generally lower risk than stocks, and as a result don’t offer as high a potential for reward. But many low-risk bonds still offer a higher interest rate than you’d earn from a bank. The safest bonds are those issued by Uncle Sam; read about them at TreasuryDirect.
5. Peer-to-peer lending
With peer-to-peer lending, you’re the bank. Individuals post loan requests on different peer-to-peer lending sites. You fund the loan and earn interest. The biggest sites are Prosper and Lending Club.
In 4 Things to Know About Peer-to-Peer Lending, we covered the potential problems: There’s no insurance, and to get the most interest you’ll be lending to riskier borrowers.
6. Real estate
A few months ago, I went in with a friend and bought the house next door. We’re still doing the remodel on it as I write this. When it’s done, we’ll rent it out and hope to earn at least 5 percent after expenses. Like a dividend stock, we also hope to make money as the house appreciates over time.
The downside? Fixing up houses is expensive, difficult, and time-consuming. So is keeping them rented. But I bought the house because I believe Housing Has Bottomed – It’s Time to Buy. In addition, the money I used to buy it was languishing in a bank account earning less than 1 percent. I couldn’t see a lot of downside, and could definitely see upside.
You can check out 15 Tips to Find, Buy, and Rent Real Estate for more.
Microloans are a way to help others while you help yourself. You make a small loan to entrepreneurs around the world – they use the money to fund projects ranging from farming in the Dominican Republic to green businesses in Argentina.
The projects you lend to are screened in advance, and the default rate is much lower than you’d imagine. Still, there’s always the risk that a good loan goes bad. In Beating the Banks: Microloans, I interviewed a man who does it.
Collecting things is a good way to combine a hobby with a potential money-maker. In Tips on Collecting From Some of the World’s Best, I interviewed two brothers who auctioned their collection of cars, mechanical musical devices, and other goodies for nearly $40 million. They have some good advice for anyone interested in collecting for fun or profit.