It's a good bet that millions of Americans would be thrilled to earn just 5% again at the corner bank.
Good luck with that.
If interest rates are stuck near current low levels for years to come, as many Wall Street pros predict, investors and savers may need a new game plan.
Here are some ideas for how to cope:
Accept that cash accounts won't pay. Since 2007, individuals and businesses have piled up $3 trillion more in bank savings accounts and money market mutual funds, lifting the total to nearly $10 trillion. Yet many of those accounts are paying close to zero interest, in line with the Federal Reserve's benchmark short-term interest rate.
Even if the Fed begins to raise its key rate in 2015, it is expected to move slowly. The upshot is that interest rates on cash accounts aren't headed back to 5% any time soon — and maybe not even back to 2%.
So if you're counting on cash accounts alone to fund your retirement, you may be facing very spare golden years.
Brian Tall, director of investments at financial advisory firm Brighton Jones in Seattle, says he tells new clients not to bother trying to predict where interest rates might go. Rather, "We want them to focus on the cash flow they're going to need from their portfolio" and build a diversified mix of assets accordingly, he said.
That doesn't mean that cash accounts are trash; it just means that a portfolio heavily in cash probably hasn't met your financial goals for the last five years, and probably won't in the near future, either.
Think about bond yields in context. Yes, yields are disappointingly low compared with their levels before the financial crisis. But if we're in this environment for years to come, the past is irrelevant. Your portfolio has to be structured for the present and the future.
Consider: The current 2.64% annual yield on 10-year Treasury notes looks paltry — except when compared with the 1.27% that German government 10-year notes pay. And U.S. 10-year T-notes are paying only slightly less than the 2.68% yield on the 10-year notes of Spain — a far riskier debtor than Uncle Sam.
"U.S. Treasuries are a reasonable value versus other countries," said Rick Rieder, co-head of Americas fixed income at investment titan BlackRock Inc. in New York.
A yield of 2.64% also looks good compared with the 1.74% yield on five-year Treasury notes, and both look good compared with the near-zero yield on cash. If it's income you need, bonds still are generating it; cash is not.
The other context to keep in mind is inflation. Say your annual inflation rate is around the Fed's target of 2% (which admittedly will seem unrealistically low to many people). That means that cash, paying almost nothing, has a negative return after accounting for inflation's bite. Bond yields above 2% at least provide a positive return after inflation.
Make sure you grasp the concept of "total return." An individual bond, or a bond fund, will pay you a certain amount of interest. That's your income return. And that return can be supplemented or reduced, at least on paper, by what happens to the underlying market value of the bond — which can move up and down like a stock, though usually not as fast.
Changes in market interest rates affect the value of a bond or bond fund. If market rates go up, older bonds that pay fixed rates can fall in value because buyers want new bonds instead. On the flip side, if market rates fall, older bonds can rise in value. The combination of your interest earnings plus or minus the change in a bond's market value is the "total return" in any period.
But some bond owners who want income don't worry much about changes in their bonds' market value, because they don't plan to sell. What's important to them is an income stream, which is always there even if the bond's market value is fluctuating.
Still, total return matters over time. How do you limit the risk of your bonds losing value? Typically, the longer a bond's term, the more vulnerable it is to losing market value if rates rise. Shorter-term bonds face less risk of value loss, because they mature faster. The trade-off is that shorter-term bonds pay less interest than longer-term bonds. You have to decide how much risk you can take relative to your income needs.
It's OK to think some bond yields aren't worth the risk now. The Fed's ultra-cheap-money policy has driven U.S. interest rates down across the board since 2008. For some financial pros, there's too little return with too much risk in some parts of the bond market.
Lori Van Dusen, founder of financial advisory firm LVW Advisors in Pittsford, N.Y., said she recently sold all of her clients' holdings of "junk" corporate bonds because yields have fallen so low. "People are doing what the Fed wants them to do, which is reach for yield," Van Dusen said. But she saysthe returns now are too paltry compared with the historical risk in junk bonds — mainly, the risk that borrowers won't repay their debts.
The average junk bond yield now is 4.97%, near all-time lows. Just a year ago, the yield was 6.44%.
"You have to stick with your discipline, and if your discipline says it's time to exit, do it," Van Dusen said.
She still sees some other sectors of the bond market, such as tax-free municipal bonds, as worth keeping.
Even in a low-rate world, bond sell-offs happen. Be ready to buy. Let's say the Wall Street consensus is correct, and interest rates overall stay repressed for years to come. There are still likely to be periodic sell-offs that drive yields up temporarily. Just as sharp investors look to buy good stocks in sell-offs, the same strategy can work with bonds.
Bond guru Bill Gross at money manager Pimco in Newport Beach expects the 10-year Treasury note yield to range between 2.5% and 4% for the next three to five years. If he's right, the patient investor will want to buy as the yield nears 4%.
What could cause a bond sell-off? Accelerating inflation. Stronger-than-expected economic growth. Or simply the approach of the Fed's first boost in its benchmark short-term rate since 2006.
A titanic sum of money has moved into bonds since 2008. Some of that money will head for the exit as the Fed gets closer to tightening credit. "Everyone thinks they're going to be the first ones to get out," warns Jim Stack, a market historian and editor of the InvesTech Research market newsletter in Whitefish, Mont.
That's why keeping some powder dry (a.k.a. cash) makes sense. With so much money crowding into bonds again this year, "even small shifts in financial conditions can cause big waves" in bond markets, says BlackRock's Rieder.
Tax-free municipal bonds tend to be particularly volatile. There have been two sharp sell-offs in muni bonds since 2010 that have briefly driven yields up, allowing bargain-hunting investors to grab higher returns. But those opportunities didn't last long, as buyers rushed in and yields fell again.
Stack advises investors against thinking that they have to make an all-or-nothing bet on future interest rates at any single point. "You manage risk by adjusting your portfolio as the situation unfolds," he said.
Be open to different ways to earn income. And focus on fees. The long decline in interest rates has forced financial advisors to search wider for income-generating securities. Their goal often is to add investments that both produce income and dampen overall portfolio volatility.
Van Dusen sees a good option in private-capital firms that funnel loans to financially strong small- and mid-size firms in Europe, where traditional bank lending remains sparse. The loans can generate returns in the low-double-digits, she said.
Advisors also have turned to so-called master limited partnerships that generate income from assets such as oil pipelines.
Many investors have embraced dividend-paying blue-chip stocks for income growth. Unlike bond yields, which are fixed for the life of the security, dividends can rise over time if corporate earnings also grow. Of course, stocks nearly always pose greater risk of principal loss than bonds.
A simple way to boost your bond returns: Use bond mutual funds that charge very low management fees. With interest rates so low, high fund fees eat up a far greater percentage of shareholders' interest returns than they did seven years ago.
Compare your bond funds' fees and returns with those of Vanguard Group, the low-fee industry leader.
Evaluate stocks in the context of low interest rates. The bull market crossed a new milestone last week, as the Dow Jones industrial average topped 17,000 for the first time. And, understandably, the higher the market goes, the more wary some investors become.
A common refrain on Wall Street is that stocks aren't cheap at these levels relative to earnings, but neither are they expensive.
What low interest rates do is make it easier for investors to justify higher stock valuations. In part, that's because investors recognize how much low rates benefit major companies. "It's an extraordinary long-term windfall for corporations," Rieder said.
If low rates persist, and the economy continues to grow, for the time being "stocks look like a much better investment in this environment than bonds," said Scott Minerd, chief investment officer at money manager Guggenheim Partners in Santa Monica.