Saving for the Short Term
Published on - July 15th, 2009 (Modified on - August 5th, 2009) (by J.D. Roth) Dave wrote yesterday with a common question. He’s looking for a low-risk investment with decent returns, but not having any luck finding one. He writes:
I currently have a Money Market Savings account and the interest rate has dropped to 1%. It used to be 5%. When it was earning 5%, I had roughly $25,000 in there, and would make something like $60-$90 per month in interest. Now I have $50,000 in there and only made $36 this month. I understand the economy is to blame for this, but I’m just looking for suggestions on where to keep my money. What would you do?
Dave doesn’t need the money immediately, but he’d like to keep it safe. He’s saving for the down payment on a house. To be honest, I don’t think he has a lot of options.
Risk and return are intertwined. In order to obtain higher returns — especially over a short period of time — he’d have to take unnecessary risks. The stock market isn’t a good place to put your money if you think you’ll need it within a few years. Stocks are great investments for retirement accounts or other long-term goals, but they’re too volatile to be considered for money you’ll need soon.
Expert advice
But are there options other than bank accounts? What about bonds or bond funds? For expert advice, I checked with three certified financial planners. They all pretty much said the same thing: Dave’s best option is to keep his money in an FDIC-insured bank.
Neal from Wealth Program wrote:
Bonds make no sense right now and the bank should be used to satisfy short-term and/or emergency money. I can understand why Dave is upset about low bank rates, but the solution is to be very clear on his objectives, execute the strategy that fits his financial and emotional needs, and accept the fact that all strategies have pros and cons.
Dylan from Swan Financial Planning elaborated about bond investing (a subject I’m just beginning to learn about):
Technically, you do not “keep” money in bonds. You buy a bond with cash and in order to get that cash back you either need to wait until maturity or someone else has to buy the bond from you.
In other words, your money is much less liquid than in a bank account. Finally, Carl from Behavior Gap added:
This is best addressed by Mark Twain: “I am more concerned about the return OF my money than the return ON my money.” People are making HUGE mistakes right now reaching for higher yields…Best to stay short in a money market at an FDIC-insured institution and when rates rise build a short 1-3 year ladder using Treasuries. Everyone can do this themselves. Then just be OK that you don’t have to worry about it.
Saving for the short term
If an FDIC-insured account is the best option, then there are three primary account types to chose from. I write about these a lot, but there’s a reason for that. These accounts should form the foundation of your financial infrastructure. They are:
- High-yield savings accounts. High-yield savings accounts (and money market accounts) are a great way to save, especially if safety is a priority. Interest rates are low right now, but I’ve seen some banks advertise 2-3%. And as the economy continues to improve, yields will rise.
- Certificates of deposit. CDs generally offer better yields than savings accounts, but at the cost of liquidity. You hand over your money to the bank for a set period of time (six months, two years, etc.) and in exchange they pay you a higher rate. For most folks, a CD ladder is a good way to maximize returns. Dave needs to be careful, though, that he doesn’t tie his money up too long — he’ll want to be able to access it when he’s ready to buy that house.
- Rewards checking accounts. Many small community banks and credit unions around the United States offer a special “rewards” checking account, a product administered by a company called BancVue. These accounts carry restrictions and requirements (you have to make 10-12 debit purchases each month, the rate only applies to the first $30,000 or so in your account, etc.), but if you meet them, it’s tough to beat the returns. Here’s a huge list of rewards checking accounts by state. There are still checking accounts offering 6%!
If I were in Dave’s shoes, I’d try to find a way to split the money between two rewards checking accounts. If he can get 6% on two $25,000 deposits, he’d earn $250 in interest per month instead of just $36! (This might be hard to do, though. Here in Portland, for example, 4.01% is the best rate I can find.)
Low-risk investing isn’t sexy, especially in the short term. There are no magic bullets. If there were some secret way to earn better returns without sacrificing risk, it wouldn’t remain a secret for long!
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It’s not ideal organization-wise, but because we’re getting around 4% in a credit union rewards checking account, we’re currently keeping the majority of our savings in there, instead of our Etrade account. We’ll do that until we stop getting a good return there, I suppose.
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It’s funny to hear how people complaint about the interest rates they’re getting. You need to take into account the CPI or inflation index to put it on perspective. If you have your $25.000 yielding 5% but losing buying power at a pace of 3.8% (2008 CPI) each year due to inflation, you’re earning a paltry 1.2%. If you have your $50.000 yielding a low 1% but the inflation is at -1.3% (last May CPI FTY), you’re earning a 2.3% on your money buying power.
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I think Neal described it best, “the solution is to be very clear on his objectives”. What’s the purpose of the money in that account and stick to the plan. It’s easy to move the money to a different investment, but will the grass really be greener on the other side?
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Dave’s right – it’s a function of the economy and what banks can lend money at. I agree with the advice given, but wonder if he could park a portion of the money (since it’s a relatively large amount) in a higher-yielding investment, but one that’s still low on the risk scale, like municipal bonds. The tax savings alone would beat the 1% yield he’s currently getting. So maybe take $10 of the $50K and put it elsewhere. Is it all an emergency fund? Or is some for retirement / other long-term investments? The portion that is for an emergency fund should definitely be kept in a liquid, FDIC-insured account.
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Return is going to be bumpy for a while. I too agree with Neal, that the primary question is what will the money be used for. If it is for an emergency fund, then you need to keep the money avaialable, but if it is a long term savings then he should definatly investigate his other options.
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I have my money in CDs and in liquid mutual funds gathering interest while I wait for it to be used.
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I’m glad you covered this topic, J.D. I’ve been wondering the same thing myself. My down payment savings is earning practically nothing, but I can’t find anywhere better to put it.
I think Behavior Gap touched on something. The reason my money is sitting in a paltry savings account is that with any other investment vehicle, the money it would cost me to withdraw my money (if I bought a place this fall) would be more than my actual return).
I wish we had interest rates higher than 1 or 2% here in Canada. If anyone knows of one, I’d love to hear about it
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One option for those with a very specific (and relatively long-term timeline) is the self-built equity-linked CD. Works like this: put enough money into a CD at X% for Y years that, at maturity, the payout from the CD equals your original principal. Then put the balance into an low-cost equity index fund. Stock market can go to zero and you (in theory) still have your principal, but you also enjoy some of the potential upside of the equity.
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@Beth.. I’m in Canada also. I have a TFSA with ING direct and they have just changed the rate to 3% on the TFSA account until October 1st.. not sure what will happen after that but seeing as it was only 1.35% before the change I was pretty happy with it.
Thx for this post JD.. I was also wondering where I could put my savings. I think I’ll sit tight for now seeing as I’m getting 3% and look at it in Oct.
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Reward checking accounts are a good option. I make 5% on my money and it is fairly easy to meet the requirements.
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I couldn’t agree more that for short term savings the return is just not that important.
Safety of principal is the main goal for a house downpayment.
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At some point we’re all going to have to consider the insolvency of banks and the currency crisis underway when we think about how to protect our capital. I think Twain is spot on–I’m more concerned about the return of my money than the return on my money.
This will surely sound loopy to most of you, but it is time to seriously consider putting some, maybe even most of your cash savings into precious metals.
I know what you’ll all say, but do your due diligence and do some research. There are a lot of good resources online.
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I’m sure this has been said before, but also keep in mind that your return on investment is not as relevant as your *real* return on investment — that is, your return minus inflation. According to historical inflation data, it looks like the inflation rate so far this year is approximately -0.5%(!), whereas last year it was 3.85%. So if your return last year was 5%, the real return was 1.15%; if your return this year is (5-3.85=)1%, your real return is (1-(-0.5)=)1.5%, which is actually slightly better.
Of course, this is an oversimplification, but the exercise is valid: one should always think in terms of real returns.
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Thanks for the article. I was wondering the same thing, having saved up a decent down payment and not sure what to do with the money currently earning 1.4% with ING. I’ll have to look into rewards checking, but otherwise, looks like I’m left with the low returns for now. (I’m not sure the idea of making the required 12 or so debit purchases a month is consistent with long-term savings account.)
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I’m in the same situation as “Dave”. I’ve got my emergency fund/downpayment fund with Vanguard money market but it’s earning nothing right now. I think I got spoiled by the high interest rates a couple years ago. I’ve been looking for a replacement, but nothing is tempting enough to deal with the hassle of moving the money.
EDIT: I would hesitate greatly to put my savings into a rewards checking account and have that money easily accessible to anyone who stole my debit card or checks. I know there are fraud limits, but that would still worry me.
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I could be mistaken, but isn’t the rate of inflation much lower now than it was back when Dave was earning 5% interest?
I’m just wondering if comparing the 5% rate to the current 1% is really comparing apples to apples. Does anyone have more info on this?
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Stick with Mark Twain and be much more concerned about return of your principal than return on your principal. Shipping your money around to weaker financial institutions to get an extra percentage point or two isn’t smart. In fact, trusting in the Fed’s fractional reserve banking system may not turn out to be smart in the long run.
Start planning for higher inflation and taxes now (yes, even if you make less than $250k per year)!
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If much of the world has gone from a state of mild inflation to mild deflation, then 1% may be a better deal than 5% used to be.
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I had been looking for that high-yield rewards checking list… thanks!
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He said that he wants the money for a house? it that a really good idea in this economic state? Because he doesnt need the money right away and he is looking to invest it, why doesnt he start a business or buy a small property and then rent it out at a price that he will have to put higher than the monthly bills so that he can get a good net income that will add up to what he wants when he needs it? But he will have to do his research though.
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One thing I found when using this rewards checking list was that I physically had to open the account, vs. over the internet. Another source of rewards checking accounts that can be opened over the internet is checkingfinder
I’ve been using these type accounts since last fall have found them to be quite a blessing. The requirements are NOT difficult to meet, but there are some in order to get these higher rates. It has turned into game to see how inexpensively I can meet the requirements, thus keeping more money earning interest.
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We’ve got a CD ladder going and the rest of our emergency fund at ING (technically a high yield but the rate is so low, I’ve been thinking about moving it to SmartyPig). If you need to stay liquid and maintain insurance on it there just are not any super options right now for higher interest.
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Thanks, LB. I must have missed your response in the posting lag.
“If your return last year was 5%, the real return was 1.15%; if your return this year is (5-3.85=)1%, your real return is (1-(-0.5)=)1.5%, which is actually slightly better.” — LB #13 comment
So, shouldn’t Dave just sit back and be happy with his return? That would be my advice!!!
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Rewards checking seems the way to go at this time, if you want to keep your money liquid while seeking the highest return possible.
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I would not advise in favor of two high-yield checking accounts. It can be hard enough to make sure you meet the debit card requirements for one (typically 12 transactions) — let alone swapping between two cards and making sure to have at least 12 transactions on each every month.
Remember that the banks are counting on many of their checking account customers failing to meet the requirements (in which case your rate drops, usually to 0% or 0.1%) — that’s how they can afford the high rates in the first place. (See this article.)
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How does a “rewards checking account” achieve returns of 5% while providing the liquidity of a money market account? The bank needs to be investing their money somewhere to make a return that is even higher: what safe investment vehicle is returning in excess of 5% to enable a bank to pay you 5%? This sounds questionable to me.
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One other suggestion: the 9-month no-penalty CD from Ally Bank. Not as high a return as the checking accounts, but fewer restrictions.
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In today’s world, I don’t see how 12 debit purchases a month is a lot. If you really have trouble making 12 purchases a month, then just go to the grocery store for packs of gum (or whatever the cheapest thing you can find is), and make as many individual transactions as you need.
If you’re worried about fraud, then check the account daily. IMHO, the few minutes a day you spend is worth saving the thousands in your account.
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CD laddering is probably the best strategy. But safety of principal is the most important feature. Would it be safe to aassume since he has 25K for short term, he would have perhaps 3-4X that for long term money? If so, I would stress about 1% on ST money if LT money is at 3-5%.
Rgds,
RB
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As others have touched on, an important thing to keep in mind here is that interest rates these types of accounts are relative to current economic activity. In other words the 1% return you get today is “like” the 5% you used to get when the economy was in a different state. Returns on things like money markets should be viewed in terms of the current inflation rate. If one was happy with 5% “then”, then one should feel the same about 1% “now”, as it is the institutions’ hope that this is actually the same return in terms of real money value.
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I think reward checking accounts are a good choice right now too. My bank offers 5% up to $25,000. I opened 4 of them and I really don’t have any trouble keeping up with them. I’m sure I’ll be making changes down the road, but for now it beats a lot of other options.
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Someone asked (or is about to ask) how a bank can make money on a 5% rewards checking account. The answer lies here. In short: interchange fees.
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Sorry, I should have wrote “I WOULDN’T stress about making 1% in ST money” not should.
It’s all about opportunity costs.
Rgds,
RB
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My wife has a coworker who invested his retirement account solely on stocks. He’s over 50 now, and once the recession hit, he lost most of his retirement.
I’m a sole believer that investing in slow and go fixed income is better than stocks in general, especially since some bond investments are tax free.
If the average return for stocks in any given year is 9%, after tax in most states, you lose one-third, yielding about 6%, and the sale of stocks might trigger AMT. For municipal bonds, I’m getting 5% tax free.
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For liquidity/emergency savings – don’t forgot to look around at your local credit unions. They general have better rates (across all specturms of products) than commercial banks. The one I use has great service and the rates exceed every adverstised rate I’ve seen from both brick and mortar and internet commercial banks.
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I disagree with the folks saying the 1% earned today is like the 5% earned last year. The “stuff” I’m buying is not significantly cheaper than when I bought it last year. Inflation may be lower, but IMO the way it is measured doesn’t mean much to me.
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Check/Card Debit Card Cleverness?
Has anyone worked out any tips to easily ensure that they meet their minimum check/debit card purchase limit each month?
Ideally I’d love to hear how people can do this online!
Thanks for any creative tips!
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CPI is a useful though potentially misleading measure of overall inflation. However, if you have money that you’re saving for a specific purchase, what matters is how the price of the thing you’re saving for is changing. If you’re saving for a house, the price is probably coming down, making the money in your savings account worth more even if it’s earning no interest at all.
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I am in the same boat as Dave. I need my money to be liquid because I’m looking for a house. But as my interest rate dropped from 5% to 1.5%, I could see a big difference in the interest each month. I have twice as much saved as I did over a year ago, yet the interest I make now is much less. Thanks for the suggestion of high interest checking, I am looking into that.
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JD.
Did you say “And as the economy continues to improve, yields will rise.”
Continues to improve??????? Nah!!! You aren’t seriously buying into the spin are you?
come on brother. The economy isn’t improving. It is worsening. At a slower pace than a few months ago pure free-fall maybe, but dying patients loose blood at a slowing pace also…because they are running out.
And the “slowing” of the deterioration is a temprorary lull before round two hits, with twice the force, in about 6 more months.
Listen man…take what I am saying as the most important advice you will see over the next 6 months regarding the economy. The storm is coming. trillions of dollars of mortgage arm resets are coming due within the next 18 months. $TRILLIONS. These are facts. Research them (google “ARM RESETS”.) Take the media’s spin, or the stock market movements with a grain of salt.
We will have issues.
Love the blog by the way.
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I would also strongly encourage municipal bonds… This is the investment vehicle strongly encouraged in “Your Money or Your Life.”
Specifically, you should purchase a low-expense municipal bond index fund. You can easily get 5% per year, TAX FREE! If you don’t need the cash in the next 2 years, its probably your best option.
Yes, there is a risk that the municipality would not be able to pay back the bondholders — like California at present — which is why you want one that is well diversified. If these bonds lose half their value, that would mean that half the states in the union are bankrupt… in which case, purchasing a house is probably the LEAST of your problems!
If you are paranoid, do a 50/50 split. Half in a one-year CD, and half in a municipal bond index fund.
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Also, check out Ally bank. They have CDs at 2.5%, with no penalty for early withdraw.
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“The “stuff” I’m buying is not significantly cheaper than when I bought it last year.”
In addition to the (continuing) drop in house prices, average gas prices are down about 35% from last year (and down 3% more in just the last week). And we just got notice that our natural gas price is dropping by 20% from last year. Car dealers around here are selling at desperation prices.
Also, prices don’t have to be dropping “significantly” to make 1% today similar to 5% in the past. If the CPI was 3% in the past, it only takes around -1% overall to make them similar.
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I keep 50% of my short term savings in a short term bond fund and 50% in a money market account. When the money market rates go down, the short term bond rates go up. When the short term bond rates go down, the money market rates go up.
I have checking account access to both accounts.
It really does seem a waste of time chasing interest rates and that is why I have all bases covered.
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Two of those small banks offering “rewards” accounts , at least here in MA, have a 1-star Bankrate rating. If the past few years have been any indication, banks that offer unusually-high rates on depository accounts are in trouble. Sure, yeah, FDIC-insured, but that fund is not bottomless.
But: Monadnock Community Bank has a high rate and a 4-star rating. While I have been a very happy USAA customer for years, their rates might as well be non-existent, so I am going to look into this one. Only downside is you have to put it all into a checking account, so no separate savings account.
*of course, Bankrate ratings might not be worth any more than Moody’s/S&P/Fitch rating were on all the trash that passed through their grabby sticky mitts.
Oh, and yeah, 5% is bad in an inflationary environment. We have not been in such in a long time. 5% now in a DEflationary environment is fantastic. When inflation comes screaming and farting back, as it will, act accordingly. This isn’t hard.
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Couple of things you might want to consider. Now they do have a higher risk level so bear that in mind.
Muni bonds was mentioned earlier. If you live in a high tax state, these make great sense. If you don’t know how to buy muni bonds, you can buy closed end funds such as BFK. Blackrock has several of these with some specific to higher tax states. It lets you have liquidity with higher yields but higher volatility as well. Not as much as a typical stock with a higher yield.
Second thing – Look to local business owners who are struggling to get loans from the bank. Invest in them at higher interest rates. I have a significant amount invested at 9% in a local business with owners that I know and trust in a business I am very familiar with. It takes some work and doesn’t give a great deal of liquidity as they will usually want a 2 year or more time frame. It also is dependent on the owners being profitable and able to pay you back. But it is a good way to get a higher return and possibly become a partner if you prefer that method of investment.
You can also look at high yield preferred funds. HPI is an example of this. It is a fund that invests in high yield preferred stocks by companies. Higher yield that the muni fund but taxable so bear that in mind.
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I think this whole question is asked with blinders on. Anyone who is still thinking about the return on their cash should realize you get more return out of spending wisely and not getting into debt. Even when the return on a money market account was 5% or whatever, the $90 you made out of keeping your money in a particular account all together like that (don’t put all your eggs in one basket) is not worth it. The way you really save money isn’t by sticking a big lump of it in a high yield account, its by wise shopping. You can easily save up $90 extra a month through the use of coupons, choosing the store with the lowest price (or buying online), and so on. So it’s actually a pretty pointless conversation. My advice to this guy is to put more effort and thought into saving on daily expenses.
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I like the rewards checking account and recently opened one myself. I was lucky to have a bank that is close, offers a 4.5% rate and they offer the rate up to $50,000 instead of the normal $25,000 limit.
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Unfortunately, low interest is the price you pay for the security and liquidity of emergency funds. Make your big returns on your retirement money . . .
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