0.01% at the Bank? Some Alternatives

Interest Rates at 0.01% at your bank! This dates me but I remember my first mortgage at 9%. At the beginning of 2020 the economy was progressing on cruise control, unemployment was at low levels not seen in 50 years and you could earn roughly 2% on your money market fund. Nobody foresaw the COVID19 pandemic, a million+ lives lost and a global recession. Little did we know that Clorox, Peloton, Netflix and Zoom would be so important in our lives. The financial markets reacted violently with stocks first plunging 35-50% and then recovering at historic speed to all-time high levels. Interest rates reacted as well. Deposits at checking and savings accounts, money market funds and other short-term investments dropped precipitously, often to 0.01%. That’s one dollar earned in one year on a $1,000 account. Talk about getting rich slowly. On the scale of things, this is not one of the biggest problems, but it is worth considering alternatives.

The Federal Reserve did what it had to do.

The Fed reacted to the COVID-induced shutdown and recession by driving down interest rates to support an economy that was in free fall. The Fed (with lessons learned from the Great Recession of 2008/2009) did a superb job and likely prevented a Depression. By driving down interest rates, they made borrowing much cheaper for car loans, mortgages, educational loans and for corporate borrowers to keep businesses running and people employed. But driving down interest rates also impacted deposits at financial institutions.

Banks, brokerage firms and other financial institutions reacted by reducing rates they paid on deposits to near zero. (It seems like a long time ago, but many money market funds were paying over 2.25% in 2019.) Banks and brokerage firms have been able to maintain sufficient depositary assets while paying little interest because these assets are “sticky”. It is a hassle to switch to alternative accounts that pay higher interest rates, but it may be worth it.

What You Can Do.

These low rates are not going to pop back up quickly again, either.  The Fed has communicated a policy to keep short-maturity rates near 0% until 2023, essentially “Lower for Longer”.  For perspective, the Fed kept rates near 0% after the Great Recession for 7 years-from late 2008 through late 2015.

With the prospect of essentially 0% for perhaps the next three years, it makes sense to consider alternatives. Although there is no silver bullet, a high-quality, short-term bond fund makes a lot of sense as a substitute for current money market holdings in cases where there is not a need for near-term liquidity.

Short-Term, High-Quality Bond Funds:  A good example is the Schwab Short-Term Bond Fund-SWSBX. There are others as well. For example, the Vanguard Short-Term Bond Fund-BSV is another candidate. In addition to purchases in Schwab or Vanguard, these funds can be purchased in many other brokerage accounts like Fidelity or JP Morgan as well.

The Schwab Short-Term Bond-SWSBX is recommended based on my Cornerstone LLC fund rating analysis.

Recommendation Rationale:
Higher Performance and Yields than most bank accounts and money market funds: SWSBX is up 4.18% for 2020 through October 23. The fund’s 12 Month Distribution Yield is 1.84% and the current month distribution yield is 1.17%.

Reasonably Conservative: 72% US Treasury’s, 28% Investment Grade Corporate bonds. Overall Credit Quality = AA.

Relatively short maturities and less vulnerable to unexpected rising interest rates. The Duration = 2.75 and Effective Maturity = 2.9 years.

Good Overall Ratings: Morningstar Overall Rating = 4 Stars (1 Star is lowest and 5 Stars is highest). Morningstar ranks it as Above-Average Return and Below-Average Risk compared to the comparable benchmark.

Lower Volatility: The NAV value increased every month in 2020, including March when stocks sank over 30%. It should be noted that this fund could have some negative monthly performance, but total return performance over a longer period of time should significantly exceed bank accounts and money market funds.

Future Performance: Fund Distribution rates and investment performance will likely come down over time as older higher-yielding bonds mature, and are replaced by new bonds that have lower yields.

As with all investments, there is a need to continue to monitor this fund and other alternatives and there may be a need to make changes based evolving market conditions.

Intermediate-Term Investment Grade Bonds represent the next step up in the risk/reward tradeoff. An example is the Vanguard Intermediate-Term Bond Index-VBIIX. This fund has a Credit Quality rating of A, a Duration of 6.5 and a Maturity of 7.4 years. This fund has returned 4.5% annualized over the last 5 years, but it represents more risk, and especially during economic recessions. This fund would also be more vulnerable to a sharp, unexpected rise in interest rates.

Other Alternatives Less Appealing:

Certificates of Deposit:
Bank and brokerage CDs are mostly locked in at very low interest rates and look less attractive. Some examples are listed below:

Schwab CDs: APY**
1 to 9 Months:  =  0.1%
10 to 18 Months:  =  0.15%
1.5 to 2.5 Yrs:  =  0.2%

Higher Yielding Online CDs-1 Yr* APY-1 Year
Ally Bank:  =  0.65%
Marcus Bank by Goldman Sachs:  =  0.65%
Synchrony Bank:  =  0.60%

Online Savings Accounts:
These online savings accounts likely offer interest rates above your local bank, but you will need to set up the online account.
Higher Yielding Online Savings Accounts* APY
Vio Bank:  =  0.76%
Citibank:  =  0.70%
Synchrony Bank:  =  0.65%

Top Online Money Market Accounts:
Online money market accounts also require setting up an online account.
Higher Yielding Online Money Market Accounts* APY
First Internet Bank:  =  0.60%
Ally Bank:  =  0.50%
Synchrony Bank:  =  0.50%.

* Source = BankRate.com as of 10/23/20
**APY is the Annual Percentage Yield.

Note: The data listed above provides an indication of rates for larger, more well-known names, and it doesn’t necessarily reflect the highest rates. Rates often vary depending on the amount deposited and some of the highest APYs may include monthly service fees. Not all rates have identical terms and conditions, and some rates may be introductory promotional rates. ATM access and fees also varies widely. It is important to carefully review the terms and conditions of each offer before making any investment. The financial institutions listed above are not specifically recommended. Data as of 10/23/2020.

In addition to BankRate.com, other online sources include:
BestRates.com
DepositAccounts.com. (Lending Tree)
BestCashCow.com.

See Cornerstone Investments for more information related to investing and financial planning

Jeff Johnson, CFA
October 24, 2020

Disclaimer:
The information provided above is for informational and educational purposes and it does not constitute personal investment recommendations or investment advice. The investment information presented is generalized and it does not take into consideration the individualized needs, objectives, constraints or unique circumstances of individual investors. Historic market trends, risks, patterns and relationships may not continue into the future and assumptions and predictions may not prove valid. Past performance does not guarantee future performance. Markets are dynamic and subject to change and all investment commentary is subject to change or revision without notice. Cornerstone uses multiple data sources wherever possible to help provide data and information that is comparable across various asset classes and is consistent over the course of time. All data and content is derived from what are considered reliable and credible sources, but Cornerstone does not accept responsibility for any errors. The user accepts all responsibility for actions taken based on information from Cornerstone Investment Associates, LLC.