Alternatives in a low-interest world

A reader writes: "My CD is maturing next month. What are my alternatives in this low-interest world?"

I field this question at least once a week, and all I can think is, "Pity the poor saver!"

To boost the economy, the Federal Reserve has been slashing short-term interest rates (the Fed Funds rate) to the historically low levels of 0 to 0.25 percent, the range at which rates have been for more than three years running. As a result, interest on everything from savings accounts to money market funds to CDs is meager at best. What's a good saver to do?

First, let's make sure that we differentiate between those who want to bump up the interest on their emergency reserve funds (12 months of living expenses for retirees, 9 to 12 months for pre-retirees) and those who have used CDs as part of their total retirement investments.

For emergency reserves, you must have the ability to access your money quickly. This is a concept known as "liquidity," and it's important regardless of your age, but even more so during retirement. Checking accounts, savings accounts, money market funds and 3-, 6-, 9- or 12-month CDs have all been the vehicles of choice for emergency funds, even while interest rates for those instruments are hovering below 0.5 percent.

But don't give up too easily! My colleague Allan Roth has directed me to a fabulous website that keeps track of the best options among the various account types,

depositaccounts.com. At this site, you will see that some banks and credit unions offer 5-, 6- or 7-year CDs at 1.8 to 2.4 percent, with minimal 60-day early withdrawal penalties. For every $10,000 in emergency reserves, you may be able to increase your earnings by $175 to $200 a year.

Another idea for your emergency reserves is Series I U.S. Savings Bonds, which have two components: a fixed rate that remains the same throughout the life of the bond, and a variable inflation rate that is adjusted twice a year (May and November) based on changes in the Consumer Price Index. Today, the first component pays 0 percent, and the second component pays 3.06 percent, which is a heck of lot better than the 0.5 percent that you're earning on short-term CDs!

How does it work? Interest from the bond is added to the bond's value each month. That means that you don't receive periodic interest payments, but rather you collect the interest when you cash in your bonds. Note that there are two downsides to I-bonds: You can only buy $10,000 per person, per year, and you have to hold them for at least one year.

For those seeking to find higher interest rates for funds other than emergency reserve funds, things get a lot trickier. Consider this: If you were a risk-averse investor who owned longer-term CDs at the beginning of the recession in December 2007, the income from those CDs has dropped by two-thirds just four years later. Ouch!

Here's the bad news: You must assume risk to earn more than the current rotten rates. If you are unwilling to lose a wink of sleep due to potential market gyrations, I'm afraid that you are stuck with reduced income. For those ready to build income-generating portfolios that move beyond CDs, you can consider adding other assets to your CDs and cash, like: short and intermediate term corporate bond funds in your retirement accounts; short and intermediate term municipal bonds for taxable accounts; and (wait for it), a small percentage allocation into a stock market index fund.

Yes, I said "stocks." I know that given the swings of the last five years, it's tough to imagine, but if you can stomach 10 to 20 percent of your portfolio in a stock index fund and you are willing to live with the inevitable gyrations, you just may be able to goose the income of your portfolio and also sleep at night.

Jill Schlesinger is the editor at large for CBSMoneyWatch.com and writes this column for Tribune Media Services.