A little over a year ago, interest rates were about as low as they could go. Now, it’s a different world, since interest rates have risen significantly. Despite this change, the national average yield for savings accounts remains close to zero at 0.25%, according to Bankrate. If you have some cash sitting in a savings account that isn’t paying you a reasonable yield, there are a few options available to generate returns.
Money Market Accounts
Offered by banks and credit unions, money market accounts are insured like savings accounts, up to $250,000 per individual holder by the Federal Deposit Insurance Corp. (FDIC) or National Credit Union Association (NCUA). Like checking accounts, they often come with debit cards and check-writing abilities. Depending on the bank, there could be withdrawal limits, monthly fees, and minimum balance requirements.
High-yield Savings Accounts
These accounts are also offered through banks and credit unions, and are thus insured by the FDIC or NCUA. It yields more than a savings account because it usually requires a larger initial deposit, and withdrawals are usually limited. Online-only high-yield bank accounts usually pay higher rates since they don’t have the costs of running a physical location, but you will need to set up transfers from another bank to deposit or withdraw funds from the online portal.
Certificates of Deposit
A certificate of deposit lets you lock up your cash at a given rate for a set period from a few months to a few years. They generally offer a higher interest rate than a money market account or high yield savings account, especially with larger and longer deposits. The same insurance limits apply to CDs as to any other bank account. If you need to make an early withdrawal, you’ll typically lose a few months of interest. The other big downside is if interest rates rise higher, you might be stuck in a CD that is paying below market rates.
Money Market Funds
These are like money market accounts, but they are offered by mutual funds and investment companies, rather than banks or credit unions. These funds invest in short-term government, municipal or corporate debt. Unlike money market accounts these funds are not insured. While banks are slower to adjust yields on their products, a money market fund’s yield tends to move up and down more closely with interest rates. Funds that invest in municipal debt have a key tax advantage: the income generated is normally free from federal income taxes. If you live in a high tax state like New York and invest in a your state’s municipal money market fund, the income may be free from both federal and state taxes.
Series I Savings Bonds
These government savings bonds pay inflation-adjusted interest rates, currently 4.3% percent for bonds issued May 1, 2023 to October 31, 2023. However, you can only redeem them after 12 months. More, if you cash it in within five years, you lose three months of interest. Keep in mind that most of the yield on new and recently issued I bonds is based on inflation, as measured by the current consumer price index (CPI) that resets every six months. If inflation continues to fall you could wind up earning much less than the starting yield. For more information on I Bonds, check out our previous article here.
Treasury Bills
A Treasury bill (T-Bill) is a short-term U.S. government debt obligation backed by the Treasury Department with a maturity of one year or less. You buy them at a discount and at maturity you receive the full face amount. For example, a $1,000 52-week T-bill would cost about $950. You can buy T-Bills through your financial advisor or direct from the federal government at TreasuryDirect.gov. Interest from Treasury securities is exempt from state and local tax, making it an attractive option if you live in a high tax state. The possible downside? Because you buy Treasuries at a discount, selling them before they mature means you won’t get all the yield you expected. Plus, unlike the previous options, these securities can fluctuate in value prior to maturity. If interest rates move higher, you are likely to see its value decline.
Short-Term Bond Funds
A short-term bond fund is typically considered to be the next rung up the risk ladder from a money market fund. While money market funds can maintain a stable $1 share price, short-term bond funds typically have modest changes in share price. A short-term bond fund invests in bonds with maturities of less than five years and is highly liquid, which means you can easily sell it at any time to access your money. They typically yield higher interest rates than money market funds, so the potential to earn more income over time is greater for those with a slightly longer investment horizon. While they are on the lower end of the risk spectrum, it is possible to incur losses in a short-term bond fund. There are a wide variety of funds with a broad range of objectives, some invest only in government or municipal debt, while others invest only in corporate bonds. And, just like money market funds, there are options that are free from federal or state taxes.
In Conclusion
Remember, letting money sit in a low yielding savings or checking account is likely to lose its value over time with inflation still running north of 4%. Now that interest rates are higher, we can at least help preserve some of our money’s purchasing power. Keep in in mind that the above options are mostly short-term focused. For longer-term goals like retirement or paying for college you will still need to incorporate a portfolio of higher returning investments that can keep pace with or exceed inflation. At the beginning of this year, you might have thought getting 4% or more on your cash looked attractive, only for stocks as measured by the S&P 500 index to be up 16.89% through the end of June. It is why balance is so important and your cash on hand should be to cover your near-term needs and/or emergency fund as part of a well-thought-out financial plan.
Presented by Carl Holubowich, CFP®
