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Low risk and high yield?

Question: Over the past year I have saved about $3,500, stashing it in online savings accounts that are yielding lower and lower interest rates. My question is, what should I do with this money? I'm wary of putting it into tumultuous stock market, but CDs and other "safe" options are yielding abysmal returns. Is there a low-risk investment that would allow me to see a better return than 1.5 percent? Thanks! Casey, Portland, Maine

Answer: The interest rates on safe savings are paltry. It's hard to get much more than a fractional rate of interest on savings accounts, certificates of deposit, savings bonds and short-term Treasury securities. Little wonder many of the questions I get involve the desire for higher yields without abandoning the security of the federal government's full faith and credit. Fact is, you're not doing bad getting 1.5%!

It's an axiom of modern finance that you can only create the prospect for higher returns by taking greater risk. You've worked hard to save $3,500--congratulations. You say you're wary of putting it into the stock market since your $3,500 could plummet in value to $2,500 or worse if the stock market lurches lower. (Of course, it could grow in value if the rally continues.) You can pick up a higher yield by buying into corporate bonds, but there is still greater risk than in an online savings account or CD.

In most cases, my advice for now is if you don't want to embrace volatility stick with safety--and low yields. Eventually interest rates will rise when the economy is healthier and you'll be able to participate in those greater yields.

Another thought: Inflation erodes the purchasing power of savings. I'm skeptical that the outcome of the Federal Reserve's unprecedented efforts to prevent a financial collapse will end in a bout of hyperinflation as some Wall Street money mavens fear. Yet even if I am right, low rates of inflation still eat away at the value of a dollar. That's why many investors are adding to their portfolios securities that safeguard against inflation. You could put some of the money into I-bonds. It's a hedge against a rise in inflation and there's no credit risk.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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