As you consider your options for short-term investments, keep three key items in mind.
1. Yield: The accounts with the highest yields typically require you to maintain a minimum balance. “Teaser” rates may apply to the first few months but drop after that. Additionally, that high yield may only apply to balances under a certain level, and you’ll earn less if you hold more than that.
2. Liquidity: If you’re willing to tie up your money for a predetermined
time—as with certificates of deposit—you’ll usually be able to earn a higher return.
3.
Guarantees: FDIC-insured accounts protect you from a loss, up to $250,000 per depositor per institution. These include checking and savings accounts, CDs, money market accounts, and online savings accounts. Money market mutual funds aren’t FDIC-insured, though funds that invest in Treasury bonds are buying securities that are backed by the full faith and credit of the US government.
CDs will typically offer the most compelling yields of all cash instruments, and they’re also FDIC-insured.
There are caveats: Minimum deposits for the highest-yielding CDs might be $25,000 or higher. You’ll usually pay a penalty if you need to crack into your holdings before the maturity date. The longer the term of the CD, the bigger the penalty. Banks offer “no-penalty CDs,” but yields are substantially lower.
Retirees or others with ongoing cash flow needs can employ a laddered CD strategy, purchasing CDs of varying maturities. For emergency reserves, however, CDs will be less appropriate because withdrawals are apt to be unplanned and could trigger penalties.
If you want daily liquidity, a decent yield, and protection, your best bet will tend to be a high-yield savings account through an online bank or a savings account through a credit union. The former offers FDIC protection, up to the limits, whereas credit union accounts are insured by the National Credit Union Administration. Minimum investment amounts tend to be lower than those for CDs, but there may be requirements to maintain a minimum balance.
Money market mutual funds, from providers like Fidelity, Schwab, and Vanguard, offer daily liquidity and the convenience of being side by side with your long-term investments. But money market fund yields are generally below those of online savings accounts today. Additionally, they aren’t FDIC-insured, though in practice most funds have done an excellent job of maintaining stable net asset values.
Don’t confuse money market mutual funds with brokerage sweep accounts. Interest rates on sweep accounts, which hold investors’ cash that hasn’t yet been invested, have ticked up recently but are still well below other cash options.
Stable-value funds, only accessible inside company retirement plans, offer an often-decent yield in exchange for not checking the liquidity and guarantee boxes. They invest in bonds, so they’re not FDIC-insured; to protect investors’ principal, they employ insurance wrappers to help maintain a stable net asset value.
There are drawbacks: First, because you can only own such a fund within a 401(k), you’ll pay taxes and penalties to withdraw your money before retirement unless you meet certain criteria. So don’t think of a stable-value fund as an emergency fund unless you’re already retired or close to it. Second, the assets aren’t guaranteed or eligible for FDIC protection.
In contrast with the preceding investment types, the income from which will be gobbled up by inflation, I bonds are the only safe investment vehicles that will guarantee to make investors whole with respect to inflation. I bonds are Treasury bonds that pay a fixed rate of interest as well as another layer of interest that varies with the current inflation rate, as measured by the Consumer Price Index. The inflation adjustment is made twice a year.
The downsides: First, I bonds fail the liquidity test. If you redeem an I bond within five years of buying it, you’ll forfeit three months of interest. Second, new I-bond purchases are restricted to $10,000 per year per Social Security number.
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This article was provided to The Associated Press by Morningstar. For more personal finance content, go to https://www.morningstar.com/personal-finance.
ChristineBenz is director of personal finance and retirement planning for Morningstar and co-host of The Long View podcast.
Related Links:
The Biggest Threat to Your Retirement Isn’t a Bear Market
https://www.morningstar.com/retirement/biggest-threat-your-retirement-isnt-bear-market
Adam Grossman: Asset Allocation Is an Investor’s Best Defense
https://www.morningstar.com/personal-finance/adam-grossman-asset-allocation-is-an-investors-best-defense
How to Protect Your Portfolio in a Changing Market
https://www.morningstar.com/portfolios/how-protect-your-portfolio-changing-market
