Dizzied by continuing volatility in today's financial markets, record numbers of investors have lost the will to invest in anything other than Treasuries and FDIC-insured CDs.
Their quest for financial security pushed Treasury yields to record lows last week, with some investors losing principal value in an asset class long viewed as immune to losing value.
But even in this volatile interest-rate environment, you can enhance your investment returns. Here are three smart strategies to leverage today's investment markets to optimize tomorrow's savings. All three are based on a fundamental assumption that you keep track of interest-rate movements that affect your primary investments.
Certificates of Deposit
With new FDIC guarantees (up to $250,000 per institution through 2009), most Americans can safely commit their funds to CDs without opening accounts at multiple institutions.
Implement a "laddered" CD portfolio approach by staggering maturities, taking advantage of long-term CDs with higher rates while including shorter-term CDs to ensure liquidity.
"A laddering strategy works because it optimizes short-term cash flow while allowing an investor access to potentially higher CD rates in the future," says Roger Steele, vice president at Wells Fargo Bank.
Let's assume you have $200,000 to invest in CDs. A laddered strategy would commit $50,000 in six-month CDs, $50,000 in one-year CDs, $50,000 in two-year CDs, and $50,000 in three-year CDs. Any investment longer than three years is a higher risk as you could lose potential returns if the investment market recovers.
Each time a CD matures, you have the opportunity to reinvest it. If markets stabilize, and you are able to tolerate risk, you can shift to stocks or bonds to capture higher-yielding returns.
Until then, be rate conscious and quick to seize higher interest rates. Note that rates on six-month CDs have fallen by more than 50 percent over the past two months from a high of 5.38 percent on Oct. 8 to 2.55 percent on Dec. 9.
Track rates at Bankaholic.com. The website also has a calculator that determines how much interest income any CD would generate over its term.
In addition, be careful not to allocate more than $100,000 to one financial institution for a period beyond Dec. 31, 2009, as insurance limits per institution are expected to revert to $100,000 after that date.
One of the more encouraging interest-rate movements is this past week's dramatic reduction in mortgage rates. As of Dec. 8, 15-year mortgage rates had fallen to between 5.13 and 5.25 percent and 30-year rates were averaging 5.38 percent.
Declining rates make now a good time to consider refinancing an existing home or purchasing a mortgage for a new home.
"Today's market is a great opportunity to refinance into major savings over time, given the lowest 30-year rates since 2003," says Brice Halbrook, a partner at Townsend & Halbrook Mortgage Corp., in Rockville, Md. "Loans are still tough to achieve above $625,000, which is the Fannie Mae loan limit in high cost areas."
To find and compare rates, visit Bankrate.com.
529 prepaid college plans
With many traditional 529 plans savaged by the market, a growing number of parents are moving away from market-based investments and into guaranteed 529 prepaid tuition plans. These plans enable parents to freeze future college tuition costs at today's prices. They can choose between state-sponsored prepaid plans, which generally require a student to attend schools in that state, or a TIAA-CREF private school plan, which locks in tuition at nearly 280 colleges.
With state budgets facing shortfalls and college-endowment funds experiencing staggering losses, parents can expect college tuitions to increase in the years ahead. So if you have children and are committed to their education, now may be the time to invest in prepaid plans, paying today's lower costs and capturing future savings.
The variations among state plans require analysis. Weigh future potential solvency risks of a state's plan – a risk that may be more troublesome, if you invest for a young child.
To learn more about the advantages of prepaid plans, visit Savingforcollege.com.