Cash is not king. With markets swooning, it is definitely in the king’s court, though.
While you should invest money that you don’t need for at least three years in stocks and bonds, if you are too skittish to invest or have some money that you need to access sooner, then let’s put that cash to work.
Getting better returns on your savings is surprisingly easy. In the time it takes you to wait in line at the Costco pumps to save a couple of dollars on gas, you could be moving your money out from under the mattress — or from traditional banks — into a number of vehicles that will actually pay you for doing business with them.
The keys to saving money rather than investing it are: 1) you don’t risk your principal, 2) you are receiving the best yield you can, 3) your time horizon matches your income needs.
If your time horizon is less than a year, two of the best places to put your money are online savings accounts or Treasury bills.
Online savings accounts are banks without the bricks and mortar, although some financial institutions are hybrids. You can link the savings account to your traditional bank so you have quick access to your money when you need it. The online accounts are FDIC-insured. Check out sites like nerdwallet.com or bankrate.com to learn about your options. In today’s environment, you should be earning over 2.3% with rapid liquidity on these accounts.
You can buy Treasury Bills through treasurydirect.com in increments of $100 or through discount brokerage firms for low fees. A one-year bill is currently paying over 4%, but even six-month bills are paying annualized rates of almost 4%. These are also free of state income tax.
If there’s at least a year before you need your money, you can expand your options. Currently, nothing compares with Series I Savings Bonds through treasurydirect.com. You are limited to $10,000 per person ($5,000 more if you apply your tax refund), though there may be ways to buy more. The rate is currently 9.65% and will soon drop, but is better than anything else you can get.
Rates adjust every six months, so you won’t know what your blended return will be until the end of the term, but you are getting a heckuva jump start. If you redeem your bond within five years, you lose three months of interest which is a small price to pay for yields like this. And again, this is free of state income tax.
Two-year brokered certificates of deposit are FDIC-insured and can currently earn 4.5% annually. If you are older than 59 1/2 (or will be when you need the money) you can also consider shorter-term annuities. The interest on annuities is deferred until you cash them in, so they can be attractive if you are moving from a higher tax year (or state) to a lower one.
These are backed by insurance companies and not the FDIC, so you need to do homework as to their credit quality. When you cash in annuity prior to age 59 1/2, you may have to pay a 10% penalty on the interest earned.
High quality municipal bonds can also be attractive. While they don’t earn as much interest, their yield usually is tax-free. Minnesota municipals are also free of state tax. There are many things to consider (like call risk and credit risk) and you don’t want to sell them before they mature because you will be subject to brokerage bid/ask spreads (the price to buy a bond differs from what you sell it at).
Cash is your safe money. You want to avoid the allure of investments that may pay more, but have either market or credit risk. Short-term bond funds are an example. They serve a place in your investment portfolio, not your cash-equivalent portfolio. Also be wary of higher-yielding bonds — again, they may fit as an investment but not a savings vehicle.
If you have more than three years before you need the money, then develop an investment approach that suits your risk tolerance and risk capacity. The after-tax returns on short term savings will at best keep pace with inflation, and in this environment will likely lag it.
In the short-term, volatility is your enemy; longer term, inflation is. With that in mind, even during these turbulent times, owning a diversified portfolio of stocks and bonds will give you the best chance to grow your assets so you can position yourself to be able to spend what you need when you want to spend it.
With interest rates going up, in the king’s court, turn your cash into a knight, not a jester.
Ross Levin is founder of Accredited Investors Wealth Management in Edina. He can be reached at [email protected]