It takes high risk tolerance to earn more on savings
— -- Invest $10,000 in the average one-year bank CD these days and, thanks to the magic of compound interest compounding, you'll earn bupkis by this time next year.
Savings rates are lower than an ant's basement — which is good for the economy but terrible for savers. If you want higher rates, you'll need either more patience or a higher tolerance for risk.
The Federal Reserve has been pushing rates down since September 2007. Currently, its fed funds rate stands somewhere between zero and 0.25%, its lowest ever.
Low interest rates will help push the nation out of recession. Low interest rates make it easier for businesses to borrow and expand. Eventually, companies should stop laying off workers and even start hiring them.
But savings rates typically follow the fed funds rate, which means that savers are getting shaved. The average money market mutual fund, for example, yields just 0.13%, meaning a $1 million account would generate just $108 a month in income.
You can fare better by locking up your money for a year. The average one-year bank CD yields about 2%, according to Bankrate.com, which tracks rates. And if you buy a five-year CD, you'll earn about 3.1% a year.
But don't reach for that five-year CD, says Greg McBride, senior financial analyst for Bankrate.com. Pathetic as today's one-year CD rates are, they are higher than the current rate of inflation. That's not a high bar: The government's consumer price index has actually fallen 1.3% the past 12 months, meaning that a dollar now has more purchasing power than it did a year ago.
Sooner or later, McBride figures, inflation and interest rates will rise, meaning that CD rates will rise, too. If you can, tough this year out with a 12-month CD, and you'll probably get a better rate when it matures.
But there's no good reason to lock into a five-year, 3.1% CD now. Inflation has averaged about 3% a year since 1926, and if the inflation rate rises, interest rates will, too. "Short maturities give you the ability to reinvest so you can continue to stay ahead of inflation once rates and inflation perk up," McBride says.
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