Five Alternatives to Traditional Savings

Reviewed: February 04, 2014
By FinanceWeb

Since the financial crisis of the late 2000s, interest rates have been stuck at historical lows. While this is great news for homebuyers who wish to lock in rock-bottom mortgage rates, it’s less welcome for savers who need to plan for an uncertain future. Yields on most traditional savings accounts undercut the rate of inflation by substantial margins, and most economists expect this “new normal” to persist for years.

Although they’re not entirely free of risks and drawbacks, these five investment alternatives to traditional savings accounts promise strong returns for short-term and long-term savers alike.

Certificates of Deposit

Certificates of deposit or CDs are conservative investments that share many characteristics of savings accounts. Whereas a typical savings account might offer annual interest of .15 to .40 percent, short-term and medium-term CDs generally offer returns of at least .75 percent. In most cases, interest accrues on a monthly basis and is paid along with the instrument’s principal on its maturity date.CD terms range from 90 days or less to five years or more. This allows savers to choose the instrument that best fits their investment horizon. That said, there’s an associated drawback: While a CD holder may liquidate the instrument at any time before its maturity date, most banks charge “interest penalties” for the privilege of doing so. Such penalties typically amount to three months’ interest.

I Savings Bonds

The I Savings Bond is a U.S. Treasury instrument that receives precious little attention. Unlike better-known Treasury bonds or T-Bills, I Bonds accrue interest semiannually at a rate that’s calculated as a function of the underlying inflation rate. After each six-month period, the Consumer Price Index’s growth rate for the period is added to a fixed rate that remains constant for the bond’s entire 30-year term. This sum is the bond’s effective interest rate for that period. Accordingly, I Savings Bonds give savers some protection against inflation.I Savings Bonds have a minor drawback: As long-term investments, they can’t be cashed out without penalty until the five-year anniversary of their issue. They can’t be cashed out at all for the first 12 months of their existence.

Peer-to-Peer Loans

Peer-to-peer loans offer far higher interest rates than savings accounts, CDs or I Savings Bonds. Depending on a given investor’s appetite for risk, peer-to-peer loans offer returns of anywhere between 2.5 percent and 25 percent. Each “P2P” loan is a transaction between two private individuals: a borrower who issues a bond with a specific principal-interest combination and a lender who forks over the funds in accordance with pre-arranged repayment terms. Like the credit rating agencies that assess risk for publicly traded financial instruments, P2P platforms evaluate borrowers’ risk profiles and assign letter-grade ratings to each one., thus an investor can choose the risk level he or she is comfortable with.

High-Yield Checking Accounts

A high-yield checking account may be the most conservative alternative to a traditional savings account. Most come with marginally higher interest rates of .5 to 1.25 percent, but many offer additional rewards to sweeten the pot. It’s not unusual to find small, regional banks that offer perks like airline miles, cash bonuses or matching deposits. With rates that occasionally approach 3 percent, online banks may offer the best deals on high-yield checking accounts.

Preferred Stocks and Corporate Bonds

When publicly traded firms need to raise money, they often float bond or preferred-stock issues on U.S. financial markets. Depending on the company’s creditworthiness, these instruments can yield as little as 3 percent and as much as 10 percent or more.While both exist to create long-term funding pools for their issuers, the distinctions between preferred stocks and corporate bonds are numerous. Most importantly, corporate bonds must be purchased in increments of between $1,000 and $10,000. For everyday savers and investors, this reduces their accessibility. By contrast, shares in preferred stocks may be purchased in any increment through a brokerage or IRA account.