With Low CD Rates, Where Do I Save?

SavingLet’s face it, as artists, we take plenty of risks with our craft. We don’t need undue risks with our investments.

Looking at CD rates last week, there’s nothing to grin about. According to Bankrate.com, the average one year CD is paying 0.23%. Looking for a higher return? If you lock your money up for five years in a CD you still are only going to earn 0.80%

To use my son’s word for lima beans, “Yuck.”

So if you’re going to save, but you don’t want risk, what do you do?

Your Time Frame Determines Your Investment

If you aren’t a risk taker, but need a bigger return than sub-one percent, the best idea is to take a look at how long it will be until you need the money you’re going to save.

If you need the money on hand for your craft or emergencies, it’s often best to look at a money market account or just leave it in cash. It doesn’t make sense to move away from guaranteed accounts if you’ll need the ability to grab it right away. On the other hand, imagine that you lock your money in a CD. Not only will you earn very little interest, but you’ll also have to pay a penalty if you remove the money early.

A good rule of thumb: Never risk any money in the financial markets that you might need in the next three years.

If you won’t need the money for at least three years, up to ten, you may want to examine bond funds. Bonds are loans to either governments or companies. Additionally, by buying a mutual fund, you’re loaning money to many companies instead of just one, lowering the risk that you’ll loan money to one company that doesn’t repay.

For shorter time frames (three to five years) it’s probably best to stick with government bonds or short-duration corporate bond funds. Government bonds are backed by the United States government (stay away from other nation’s bond funds if you live in the USA because not only are you investing in bonds, but you also will experience currency fluctuation). “Short duration” means you’re only loaning the money to companies for a short time. Historically these funds are safer because it’s a short term loan and mutual fund managers can easily assess whether the company will repay the loan.

For five to ten year periods, intermediate term and long term bond funds (often called “income” funds) may be a wise choice. These longer term loans will give you a bigger payout and because you have a few more years you can ride out any short-term volatility.

Historically, intermediate and long term bonds aren’t incredibly volatile investments, but remember that time reduces your risk in a fund. Between investing in many different companies and being patient, historically you’ve been rewarded.

Only if you have at least ten years should you look at stocks, if you’re conservative. I’m always surprised when a person tells me that they’re buying a stock fund and are hoping for an immediate return. Over the short run stocks are incredibly volatile. You’re biting off a huge risk…especially if you’re someone who wants to pay attention to your craft rather than your portfolio. What surprises people is how safe stocks have historically been if you have ten years or more.

I’ll explain. Between 1950 and 2012, if you bought the S&P 500 and held it for one year your return was anywhere from +51% to -37%. You’d probably have more fun just going to a casino! But if you hold on for five years, your returns were anywhere from +28% to -2%. Look at how much less risk of losing money you had if you held on!

But remember, we’re conservative, so we want to hold longer. Over a ten year period your best return would have been +19% and your worst was -1%. If you’d held for twenty years, your top return was +18% and your worst was 6%.

A good rule of thumb: Use stocks or similar investments (like real estate) if you can hold them for a long period of time.

So, What’s the Point?

Current CD rates can make you think that there aren’t opportunities for your savings, especially if you’re a conservative person with your money. But if you look closely at how long until you need the money you’ll increase your chances of finding returns better than CDs could pay even in better times.