The Downside of Easy Money

My daughter, Claire, recently asked me where she and her husband, Zach, could get a higher interest rate on the savings they’ve been diligently squirreling away in the bank. Nowhere, I reluctantly told her. Because she and Zach consider the money their rainy-day fund, there’s no sense taking a chance on some exotic (read risky) investment to squeeze out more yield.

It bothered me that I couldn’t give Claire a more satisfactory answer. Analysts and the media have focused on how the Federal Reserve’s policy of near-zero interest rates has boosted the stock market. But not enough attention has been paid to the negative effects on ordinary savers.

Stockholders have benefited from the run-up in prices as dividend-hungry investors have piled into the market and companies have binged on share buybacks. And ultralow rates have saved the Treasury billions of dollars in interest on government debt.

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Meanwhile, the national average interest rate on a money market deposit account was recently 0.08%; on a one-year CD, it was 0.27%. A 65-year-old who wanted to pay for retirement with annuities tied to bonds needed 24% more wealth in 2013 than in 2005, according to a paper by the National Bureau of Economic Research. And in a survey by Ameriprise Financial, 63% of respondents said low interest rates had derailed their retirement plans because their assets were growing so slowly.

In stretching for yield, some investors have turned to riskier products. One of these, non-traded REITs, has been targeted by state regulators for high fees, inadequate disclosures and questionable dividend payments.

For savers like Claire, who need to keep their emergency funds safe and easily accessible, there’s no alternative to a basic savings account. If you are able to tolerate a little more risk, senior editor Jeff Kosnett vets the alternatives in his monthly “Cash in Hand” column—which this month we’re rechristening Income Investing to reflect his specialty. Over the past year, while many pundits fretted over rising interest rates, Jeff kept his cool with columns headlined The Bond Rally Isn’t Over and 3 Reasons Investors Should Ignore the Doomsayers. For the coming year, writes Jeff, “expect interest rates to rise slightly and returns to moderate. But there’s no need to panic.” For more in-depth coverage, you can follow Jeff’s analysis of the fixed-income market in Kiplinger’s Investing for Income, the monthly newsletter he edits ($199 for one year).

Cloudy future. Aside from its negative impact on savings accounts, I worry that the Fed’s easy-money policy may represent a classic case of hubris. Low rates are responsible for a good chunk of the run-up in stock prices, but it’s not clear how much. Further, it’s impossible for the Fed to manipulate a trillion-dollar economy without risking unintended consequences (just ask Alan Greenspan). That’s a major source of uncertainty and a cause of continued volatility that makes it tough to call the course of the market in 2015. “We continue to see a large number of investors who lack confidence in this market,” says Kristina Hooper, U.S. investment strategist for Allianz Global Investors (see Allianz Analyst Sees U.S. Stocks in the Lead).

So what’s an investor to do? Stick with stocks, but do whatever it takes for you to blissfully ignore gut-churning gyrations: Diversify your portfolio, balance your stocks with some of Jeff’s bond picks—or even stash a wad of cash in a low-yielding savings account.