Previously I discussed the expectation that more bank failures are coming. I posted a little comic within that article on the safety of investing in the space under your mattress. How many of you are doing just that? Maybe you are doing it without even realizing it?
This article is going to give a brief overview of the basic places in which we can put our excess money… Hopefully you have extra money, right? If not, do not worry, you have plenty of time to create a budget and start saving some money!
Under the Mattress (Cash)
Obviously, this is a very conservative “investment.” The reason I put investment in quotes? Investing usually implies that you are doing something with your money with an expectation of future profits. I guess you could make the argument that putting your money under the mattress essentially is making a profit as long as the market keeps tumbling, but that would be letting silliness preside!
So what would some of the advantages be to keeping the money in your house? The money is extremely flexible. You need to get a car towed and they say you have to pay cash? Well, you have it in your house! Anything that you need to pay for can be paid for with cash and immediately. No chance of getting in debt that way, eh? Not so bad. Unlike other options, you can obviously take from your principal at any given time.
Unfortunately, all you have is principal. No interest will be earned… unless you are paying yourself interest? Without earning interest you have no chance to keep up with inflation. I think we can cross this option off immediately.
However, My Money Blog did have an interesting article on “The Permanent Portfolio Asset Allocation” where he posted this image:
The assertion here is that some asset classes perform better depending on the economic climate. Being that we are in a recessionary state, cash should outperform other asset classes (Note: “Cash” does not mean keeping it in your house, it means keeping it in a like-cash account). I will be going over more sound ways to keep your money in cash without stashing it away under a mattress.
Savings accounts are accounts that financial institutions maintain and pay interest on.
They are great in that they are FDIC insured for $100,000 normally and $250,000 temporarily. You don’t have to worry about losing your money under your mattress or in a hole in your backyard. Or when a bank fails since the FDIC will not let the deposits vanish. If you need quick access to your money, like in the case of the tow truck driver, you can usually go to an ATM and withdraw money from your account. Small fees may be charged ($1-3) or it may be free if it is from the financial institution the account is with.
What do you trade-off for these benefits? Income and accessibility. Savings accounts generally pay low interest rates. At the current time a lot of accounts are paying 0-2% and the highest you can find is usually 3% or so. Money Rates has the highest interest rate at 3.3% with all of the others falling below 3.05%. And didn’t I just mention how accessible the money is if you have an ATM locally? Yes, but it could be more flexible… like if you could write a check.
Checking accounts are considered transactional accounts because they are held at financial institutions and designed for the purpose of allowing people to frequently deposit, transfer, withdrawal, and otherwise access their funds.
An advantage of a checking account is that it provides more flexibility than a savings account since it allows you to use both ATMs and checks. A lot of things are best paid in check, like rent and some bills that don’t offer e-pay, so I consider this a huge advantage. This may be an advantage to you, or it may be inconsequential.
However, if you thought the interest rates savings accounts offer is bad, checking accounts usually pay less interest, ranging from 0-2%. Using the same link mentioned above, you may find interest rates at 2.5%. But once all the dust settles and the introductory offers are over you will find the highest rate around 1.8%… a full 1.5% lower than the highest savings account. Some even charge you fees for “account maintenance.” These fees can be from $0-20 per month which could essentially wipe out any interest earned. This is not a fair deal for you.
Certificates of Deposit (CDs)
A CD is an interest-bearing fund issued by a bank or other financial entity promising to repay the money that was deposited plus a defined interest rate after a certain period of time. The agreement is evidenced by a certificate.
These investments have a time-horizon of anywhere from 3 months to 10 years. The interest rate is set initially and on larger amounts can actually be negotiable.
The benefits of a CD are that usually the interest rate is higher than any of the aforementioned options. Right now the rates are running between 2% and 3%. If you go for a longer term CD (around 5 years) you can get closer to 4% right now. The rate is locked in and the CD is usually insured by the government. Generally speaking, the longer the term the higher the interest rate. It is important to shop around as different banks can offer significantly different rates.
The downside? The money is there for a set period of time… you can not withdraw without penalties! And if you want a good interest rate you may have your money locked in for 5-years+. And what happens if you lock into a 5-year CD in order to get a 3.7% interest rate and in 2 years savings accounts jump back up to 5% interest? Now you are actually losing out on potential interest income. It is hard to weigh the optimal term. There are also minimum investments. The amount varies by bank, but is usually at least $500.
Money Market Funds
Money Markets are actually a type of mutual fund that allows investors to manage their money immediately. How do they do this? They hold huge quantities of short-term securities. Some of these securities even mature weekly, if not daily.
What are some of the other advantages of money market funds? They combine a few of the positive aspects of the other accounts. They generally will pay you more interest than a savings account. Often times they also pay higher rates than CD’s. However, at the current time their rates are on par with savings accounts at around 3%.
Also, just like with checking accounts, you are often times able to write checks and unlike CD’s you have free access to your money without fear of penalties.
Wow, money markets seem to have all the benefits, huh? Yup, they do… but there are a few drawbacks of course!
As I have experienced multiple times (damn you, AmTrust!) money markets rates can change like the wind. One day they may be 5.3% and a month later they could be 4.1%. This is the downside to not locking in your rate like you can with a CD. That being said, they will still usually be higher than a savings account rate. These funds are also not FDIC insured so you could potentially lose your money. But the odds are on your side — Only 1 money market in the United States has ever lost value and liquidated.
I mentioned the ability to write checks but there are stipulations around this. If you want to write a check at the grocery store, no can do. These checks usually have minimum amounts. You will most likely only be able to pay for larger payments like rent from your money market.
Some money market funds have even started reinstating fees due to the current economic turmoil, although not all of them have so be on the lookout!
And just like CDs there are minimum deposits. These minimums are higher than the ones CD require, though. Usually to the tune of $1,000+. But the cash remains liquid, so there is less risk.
After these options you are mainly looking at bonds, stocks, mutual funds, ETFs, indexes, etc etc. I will go in to more depth on each of these topics in later posts! But that is all for the more liquid options!
The safest bet as far as getting a good return while maintaining liquidity is Money Market Funds, in my opinion. They offer the best rates out of the four options (usually!!), though quite similar to CD rates. However, they are not backed by the government as the other three are. Each option has its pros and cons and you will most likely find yourself using an interesting mix of all of the options. But if you are trying to decide where to put an emergency fund (needs to be liquid), I would opt for a Money Market Fund. You can go to Vanguard or Fidelity to learn more!
If you are leery about the Money Market Fund, then I would say a CD ladder is the next best option. If you do either 3 or 6 month steps in your ladder, you could maintain a good degree of liquidity, an agreed upon interest rate, and government backing.
Any questions or suggestions, leave a comment!