4 Alternatives to CDs That Pay 2x the Interest
Question: My CD is expiring and I'm not thrilled about getting 1% interest from a new one. So I'm thinking about switching into a safe-but-non-FDIC-insured product to get a higher yield. What other options do I have that would carry relatively low risk?
Thanks for your question, Alice. This question has become commonplace for the past decade or longer as people have grown tired of settling for historically-low interest income from their certificates of deposit accounts (CDs).
Fortunately, there are a number of low-risk alternatives that can generate much higher income than a CD. It just all depends on how soon you'll need access to your invested money.
Bank CD Alternative #1: High-Yield Bank Accounts
Unlike CDs which can tie up your money for several months or years, money market accounts (MMAs) and savings accounts allow you to freely withdrawal your money at any time while also paying annual percentage yields (APYs) that are comparable to a one- or two-year CD.
Bank CD Alternative #2: Short-Term Bond Funds
Short-term bond mutual funds with low expense fees can also be a great alternative to a bank CD. Bonus: There's no withdrawal penalty, which makes it easy to access your money as soon as you need it.
The T. Rowe Price Short Term Bond Fund (NYSE: PRWBX), for example, invests in a mix of low-risk corporate bonds (with an average AA credit rating), government bonds, mortgage bonds, and asset backed securities, among other sectors.
The bonds held within the fund have an average maturity of less than two years -- making PRWBX much safer than a long-term bond fund that would face a significant price decline if long-term interest rates went up.
PRWBX has a minimum investment requirement of $2,500 but offers an attractive yield of around 2% (minus the expense fee of 0.46%, which is well below the category average). Similar funds worth checking out include the Vanguard Short-Term Bond Index Fund (NYSE: VBIRX), the Lord Abbett Short Duration Income Fund (NYSE: LALDX), and the Vanguard Short-Term Bond ETF (NYSE: BSV).
Bank CD Alternative #3: I-Bonds
Issued and backed by the U.S. government, the I bond is designed to keep pace with inflation, so it adjusts its interest rate every six months as inflation fluctuates. Every dollar you invest in an I-Bond is also tax-deferred (like an IRA contribution), meaning you're only taxed on earned interest after you redeem it.
In recent years, the I-Bond has paid an APY between 2.5% and 3.5%, but as always, there is a catch. You must hold the I-Bond for at least one year, without exception. And if you redeem an I-Bond within five years, you must forfeit your last three months of interest -- causing your actual yield to drop slightly in the year you incur the penalty.
You can purchase I-Bonds commission free in $25 increments at TreasuryDirect.gov up to $10,000 per person. The bonds are then sent electronically into your designated account.
Bank CD Alternative #4: Reliable Dividend Stocks
Many risk-averse investors fear putting their money in stocks for the short term, quite understandably. But there are many that pay steady and reliable dividends, which could land you income yields of 2% to 5% per year on your original investment -- easily twice that of a typical CD.
A special class of dividend-paying stocks called the Dividend Aristocrats are comprised of 53 large US companies that have not only paid dividends to those that have invested in them but have increased them for 25 consecutive years or more.
Unsurprisingly, most of these stocks are household names (think 3M, AT&T, Chevron, The Clorox Company, and Coca-Cola) with cash-rich balance sheets that dominate their markets -- making them a less risky investment than most stocks. Do an online search for "dividend aristocrats" to learn more on these high-yield investments.
The takeaway: If interest rates look like they're heading higher, it might be smart to strike a balance between liquidity and interest yield in any investment you choose. For example, tying up your cash in a 5-year CD for 2% APY may not be worth it if a much more liquid money market account has an interest rate of 1.75% APY, because the MMA would allow you to move your cash into a higher-yielding investment faster (or with no penalties) if interest rates went up.
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