Solutions for Short-Term Savings:

Over the past 10 years, cash has been a poor place to generate a return on investment. However, the Federal Reserve increased interest rates substantially over the past year, which gives investors an opportunity to earn a decent return on their short-term savings. Below I will discuss some potential options for investors looking to take advantage of the increase in short-term interest rates.

Savings Accounts

Savings accounts can be opened at traditional and online banks, as well as credit unions. They are a relatively safe place to invest funds because the deposits are insured through the FDIC for up to $250,000 per depositor per bank, and $500,000 for joint accounts. They are liquid, meaning that the depositor has the ability to withdraw quickly and easily, usually within a day or two. Many banks are now offering savings account with interest rates ranging from 3%-4.5%, depending on the bank. It is important to review the interest rate on your current savings account and check with your bank to see if there may be any better options available to you.

Money Market Accounts

Money Market accounts are interest paying depository accounts found at traditional and online banks, as well as credit unions. Like savings accounts, they are insured through the FDIC. They may require a minimum balance to open and may have limits on withdrawals. The biggest difference between the two is that money market accounts often pay a higher rate of interest on deposited funds than savings accounts. Currently financial institutions are offering money market accounts with interest rates ranging between 3% and 5%, depending on the institution.

Money Market Funds

Money Market funds are securities purchased through a brokerage firm. They often pay a higher rate of interest than a savings account, and the funds can easily be sold and accessed, usually within a day. The difference between money market accounts and money market funds is that money market funds are not insured by the FDIC. Because money market funds are a security and held in a brokerage account, they are insured under SIPC, (The Securities Investor Protection Corporation), which insures against the loss of cash and securities held by a SIPC member brokerage firm, if the firm were to fail. The protection limit is $500,000 for securities, which includes a $250,000 limit on cash, per customer. Interest rates on money market funds will vary between funds and over time. However, currently money market funds have interest rates that range between 4% to 5%. For example, Charles Schwab’s Value Advantage Fund (SWVXX), currently pays an interest rate of 4.92% and Fidelity’s Money Market Fund (SPRXX), currently pay an interest rate of 4.79%.

Treasury Bills

A Treasury Bill or “T-bill”, is a short-term U.S. government debt security that has a maturity of one year or less. In essence, they are “IOUs” to the investor from the U.S. government. Because they are backed by the U.S. government, T-bills are considered to be relatively safe. They are liquid, and can easily be sold on the secondary market. They are usually sold in denominations of $1,000, which is their face value, and are issued at a discount. When a T-bill matures, its face value is paid to the investor, and the difference between the purchase price and the face value paid at maturity is the investor’s return.

Interest income on T-bills (gain if held to maturity) is exempt from state and local income taxes. They can be purchased directly from the government on the TreasuryDirect website, or through most brokerage firms. It’s important to know that you cannot to sell a T-bill purchased through the TreasuryDirect website; you will need to transfer the T-bill to an outside bank or brokerage to sell it.

Certificates of Deposit

Certificates of Deposit (CDs) are an investment where a fixed amount of money is deposited with a financial institution for a fixed period of time in exchange for a pre-determined interest rate. They can be purchased at banks, credit unions, or brokerage firms, and they are often insured through the FDIC. A benefit of fixed rate CDs is that the pre-determined interest rate is normally “locked-in” for the contract term, giving the investor a guaranteed return when held until maturity. Fixed rate CDs are primarily used for short-term savings, but there are also different types of CDs such as variable rate CDs and stepped-rate CDs, which may be used for longer-term savings such as a 5-year period or longer.

Usually, higher interest rates are offered on longer-term CDs. Investors often “ladder” CDs, by purchasing a number of CDs with different maturities. This allows the investor to lock in interest rates on different blocks of money over different periods of time. A drawback to many CDs is that there are usually penalties (often 3 months of interest), for withdrawing funds before the maturity date. When a CD is purchased through a brokerage firm, an investor may have the option to sell the CD on the secondary market. However, selling the CD prior to maturity may result in a loss to the investor if sold for less than the purchase price. Currently fixed CD rates can be found in the 4% to 5.5% range, depending on the institution and maturity date.

An easy way to compare interest rates on different savings accounts, money market accounts, and CDs is through bankrate.com. You may also consider asking your bank or financial planner what options might be available to you, and before deciding on investing in any savings vehicles, you should understand how the investment works and how it fits into your overall financial plan.

Brandon Bergeron

Portfolio Manager, Crescent Sterling Ltd.