With interest rates so low, where do you put cash now?

Savers have been frustrated by super-low short-term interest rates since the 2008 financial crisis forced central banks worldwide to slash rates. Despite forecasts that government stimulus spending and rising national deficits would spark inflation and higher rates, inflation and interest rates have remained stubbornly low. What is a saver who wants a decent interest rate to do?

The chart of U.S. Treasury security yields, known as the “yield curve,” shows interest rates up to one year’s maturity at their lowest levels since the Great Depression (near zero). The curve swings sharply up from there, but the “high” rate you get at a 30-year maturity is a mere 4 percent—not much reward for taking a bet that inflation will not come back sometime within 30 years and wipe out your payments. Banks are paying virtually nothing on checking and savings accounts, and about 1 percent on one-year certificates of deposit. Money market funds also pay little, and may pay even less in the near future as new federal rules designed to make them less risky take effect.

The Federal Reserve, which is currently worried about a slowing economy and deflation, says it expects to keep rates where they are for an extended period. Forecasters interpret that to mean the Fed won’t begin raising rates until sometime in mid-2011. Also, when the Fed raises rates it usually does so slowly, at one-quarter of one percentage point per month. If rates start rising in mid 2011, we wouldn’t see 3 percent short-term yields until mid-2012 at the least.
Savers have two competing goals: liquidity—the ability to get at their money quickly without loss—and yield. Some strategists advocate a two-tier approach to today’s low rates, where a saver would divvy up his liquid assets into two portions. One would be invested for liquidity in low-rate bank deposits and/or money market funds. The other portion would go into short-term bonds or bond funds with maturities of one to four years. These investments would offer higher yields, while the banking portion would offer immediate liquidity.