Date: June 16, 2017
With interest rates today at rock-bottom levels, it’s understandable if you feel that low-risk savings options are not much better than stuffing your money in a mattress. But our topic here is not maximizing your return over the long term, we’re looking at where to put money you may need to access quickly. The focus for these funds is safety and liquidity, not a great return. Here’s a look at the pros and cons of potential savings vehicles.
Savings and Checking Accounts
Savings accounts are bank accounts that earn interest. Checking accounts are accounts on which you can write checks.
Pros: These traditional bank accounts are readily accessible and FDIC-insured.
Con: They pay little or no interest.
Who it’s good for: These accounts are necessary conveniences for most people. But if you’ve built up significant savings, it may make sense to move some of that money to higher-yielding savings vehicles like those listed below.
Certificates of Deposit
A certificate of deposit is a deposit you make for a set period of time. Your fixed interest rate depends on the term of the CD.
Pros: You’ll earn a little more interest for tying up your money for a longer period of time. For example, a two-year CD currently pays a little more than 2%, while a five-year CD pays almost 3%. And your money is FDIC-insured.
Cons: If you put your money in a five-year CD, for example, you’ll be unable to take advantage of a rate increase if market conditions change during that time period. Most CDs also require a minimum deposit and you’ll pay penalties for withdrawing money before the end of the CD term.
Who it’s good for: As long as you don’t need immediate access to the money, CDs can help you build savings in a very safe way. A technique called “CD laddering” can help you keep some of your savings available while making the most of CD interest.
Money Market Deposit Accounts
These are bank accounts that invest in very short-term corporate loans and CDs.
Pros: These accounts pay higher interest than traditional savings accounts. Your money is FDIC-insured.
Cons: You’re limited to writing no more than three checks a month. Some banks limit your cash withdrawals.
Who it’s good for: Money market deposit accounts are better choices than CDs for money you might need to tap at a moment’s notice to cover an emergency or an unexpectedly large expense. They pay higher interest than ordinary savings accounts and give you immediate access to your money
Money Market Funds
Money market funds invest in highly liquid, very low-risk securities, including government bonds, certificates of deposit, and 30 day loans to top-rated companies.
Pro: You earn an interest rate that fluctuates daily with the market.
Cons: You’re permitted withdrawals and check-writing privileges, but you may be limited to writing checks for a minimum of $250. Your money is not FDIC insured.
Who it’s good for: Money market funds are appealing if you want to earn the highest current short-term interest rate and still have immediate access to your money. But don’t confuse this type of account with a bank’s money market deposit account! Although money market funds are considered extremely safe— only twice in the history of these funds have investors ever lost money—they aren’t FDIC-insured.
Short-Term Government Bond Funds
These are mutual funds that invest in bonds issued by the U.S. government and its agencies.
Pros: These funds hold bonds that are backed by the full faith and credit of the U.S. government, and have an average maturity of under three years. And they’re safer than bonds with longer maturities.
Con: The value of the bonds in the fund fluctuates constantly. As a result, when you sell your shares, you may get back more—or less—than your original deposit.
Who it’s good for: Consider these funds if you’re willing to assume a little more risk in exchange for higher potential earnings, and you won’t be writing checks on the account. The best way to tap a bond fund is to have it mail you monthly dividends. Note: When you write checks on the fund, you’re selling shares; that creates a gain or a loss that you must report on your taxes.
I-Bonds
I-Bonds are inflation-linked savings bonds issued by the U.S. government. They have two components: One is fixed and remains unchanged for the 30-year life of each bond. The other is adjusted every six months to reflect changes in the Consumer Price Index.
Pro: I-Bond interest is exempt from state and local taxes
You can defer the federal tax until you cash in the bonds or until they reach final maturity, whichever comes first.
Con: You can’t redeem these bonds for at least a year; and if you sell them within five years, you’ll forfeit the three most recent months’ interest. In other words, consider them as an alternative to a five-year CD, not to a money market fund.
Who it’s good for: I-Bonds are a good choice if you want to be certain that your earnings will outpace inflation and you can afford to tie up your money for five years.
Remember that what you want for this money is safety and easy access. So you should expect to get a much lower return than you’d earn with an investment you’re holding for a long-term goal such as retirement.
