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There are many reasons why you might want to keep some of your assets in a savings account. You might need it as an emergency fund, or you have a short-term goal you are saving for. You could also be parking it there because you are concerned with the volatility of the stock market. People near or in retirement tend to keep more of their money in a short-term savings vehicle because they are more liquid and generally safe.
The default vehicle for most people who use a savings account is its convenience and accessibility. Also, they are more comfortable having their money where they also do their checking. The problem, especially for retirees, is the yield on savings accounts is currently next to zero with many traditional branch banks.
At best, it is a place to keep your money where you know it will be absolutely safe and available. But, if you are hoping to generate any kind of return, you might have to look elsewhere, and it could help to use technology such as mobile investment platforms.
Fortunately, there are alternatives that can produce better returns without substantially increasing your risk.
Best Apps for Short-Term Investments
One of the best ways to make great short-term investments is through the various investment apps out there that make it quick and simple. We reviewed the top 2 apps for you here. You can see the basics of each below.
|Invest In||Stocks, ETFs, Bonds||Stocks, Mutual Funds, ETFs|
|Fees||0.25% – 0.40% annually||$4.95/trade for stocks & ETFS, $9.95/trade for mutual funds|
|Best For||Long-term investments||Beginner stock trading|
|Compare Betterment, Ally, and other top investment apps!|
Money Market Account
Money market accounts are similar to savings accounts in that they are both liquid and interest-bearing accounts guaranteed by the Federal Deposit Insurance Corporation (FDIC). However, unlike savings deposits which credit an interest rate based on the prevailing market interest rates, money market accounts are similar to mutual funds that invest in short-term interest-bearing instruments such as commercial paper and Treasury notes. Because it is a managed portfolio, the yields tend to be higher than those available with savings accounts, but they are also variable, meaning they can increase and decrease with changing market conditions.
Money market accounts are often available in tiered rates with higher rates available for larger deposits. For example, the account may be tiered with a low range of $0 to $10,000 earning the lowest rate, $10,000 to $50,000 earning the next highest rate, and accounts with more than $50,000 earning the highest rate. Also, many money market accounts may charge fees if minimum deposit and/or balance requirements are not met.
In comparison, the national average yield on money market accounts as of August 2017 is 0.08 percent versus 0.06 percent for savings accounts. Money market accounts offered by traditional banks tend to have lower yields than those offered through online banks. For example, Bank of America’s money market rates currently range from 3.0 percent for deposits under $2,500 to 5.01 percent for deposits over $2.5 million. Ally Bank, an online-only bank offers an APY of 0.85 percent on all deposits. If you have more than $10,000 to deposit, you can earn 1.10 percent with a Capital One money market account. For deposits under $10,000, Capital One pays 0.6 percent, still much higher than the yield on low balance money market accounts with traditional banks.
Different from Money Market Funds
It is also important not to confuse money market accounts with money market funds. Money market accounts are offered through banks, while money market funds are offered through brokerage firms or mutual fund companies. Although money market funds are managed in the same way as money market accounts, they are not FDIC guaranteed. Money market funds tend to offer higher yields than money market accounts, but there is slightly greater risk with them. While it is not very likely, money market fund investors risk losing value because they are subject to market trading rules while money market accounts are not.
Certificate of Deposit
Certificates of deposit (CDs) are savings certificates issued by a bank with set maturity dates. CD maturities can range between 30 days and 60 months, with longer maturities receiving higher yields. If held to maturity, CDs return the original deposit along with the interest that has accrued during the term of the CD. Generally, if you attempt to withdraw your money before the CD’s maturity date, you will be charged a penalty. For that reason, CDs aren’t quite as liquid as a savings or money market account, so it is important to weigh your need for liquidity with the level of yield you are seeking.
The rate you receive on a CD depends on the length of the maturity as well as the amount of the deposit. A 30-day CD rate is comparable to the rate available on savings accounts. The current national average yield on a 30-day CD is 0.06 percent. If you can take a longer term with your CD, you can earn a higher yield. The average yield on a 12-month CD is 0.29 percent. For a 24-month CD the yield jumps to 0.41 percent and for a 60-month CD the average yield is 0.85 percent.
Again, most of the higher yields are available from the online-only banks. For example, you can get a 12-month CD from EverBank yielding 1.56 percent while a 12-month CD from Wells Fargo starts at 0.05 percent for deposits under $5,000, topping out at 0.10 percent for deposits over $100,000.
Building a CD Ladder
With a range of maturities available, depositors can balance their need for liquidity and better yields. A popular strategy used by depositors to remain flexible in anticipation of rising interest rates is to “ladder” their CDs through a combination of maturities. The net effect of this strategy is the ability to capture higher interest rates as the CDs mature while always staying invested. It also provides a degree of liquidity because you will have CDs maturing each year.
A CD laddering strategy works like this: You deposit equal amounts in a 1-year, 2-year, and 3-year CD. After the 1-year CD matures, you roll it into a new 3-year CD. You do the same when the 2-year CD matures. At that point, you will have a 3-year CD maturing each year that follows. You could also increase your yield by laddering with 5-year CDs.
Investing in Peer-to-Peer Lending
For even higher yields, you will have to step outside of the realm of banking products which could introduce more risk. One alternative that can satisfy yield seekers at the cost of greater risk is peer-to-peer (P2P) lending. P2P lending, popularly referred to as social lending, is rapidly becoming a portfolio addition for many investors.
Peer-to-peer lending has emerged as a preferred source of loans for many individuals and businesses still facing difficulties in obtaining conventional financing from the banking industry. In addition to the availability of financing at lower rates, many borrowers are attracted to P2P simply because it is the “anti-bank.” The concept was born out of the convergence of Web 2.0 technology, social networking, and the preference for community collaboration in solving local problems. P2P lending companies, such as LendingClub and Prosper, use these technologies to bring together a community of borrowers and lenders whose financial interests can benefit one another. Borrowers need financing at reasonable rates, and lenders are actually investors seeking higher yields. It’s a rare win-win situation, but just to reiterate, it carries more risk than a typical account mentioned earlier.
The success of P2P lending is predicated on the quality of the investment offering, so these companies must be very selective in the loan requests they allow to be posted. They tend to only approve requests made by “prime” borrowers, those with credit scores of 650 or above and good overall risk profiles. As a result, they decline nearly 90 percent of loan requests. This is the only way they can promote a stable income to investors with only a moderate risk exposure.
Investors can “loan” as little as $25 to any borrower they choose. They can spread larger amounts around to dozens or hundreds of borrowers. The loans or “notes” are offered to investors by a prospectus which details the loan request, risk profile, and the background of the borrower. The interest rate, or yield, of each note is established individually based on the risk profile and the loan term. Notes offered through borrowers with very good credit might yield 5 to 8 percent while notes offered through less creditworthy borrowers could yield as much as 15 percent.
The key to minimizing your risk is to create a diversified portfolio of loans. With a minimum investment of $25, you can invest in 100 loans with a $2,500 deposit. That will allow you to select a mix of high quality loans yielding 5 to 7 percent, mid-quality loans yielding 8 to 12 percent, and lower quality loans yielding 13 percent or more. If you are more conservative, you can weight your portfolio towards higher quality loans, and if you are willing to assume a little more risk for a higher return, you can weight it towards mid- to lower-quality loans. You can change your allocation as your circumstances change. For instance, as you get closer to retirement, you can move towards higher quality loans.
Liquidity is a Little Tricky
The loans typically have maturities of three to five years and, as they are paid off, you will receive your initial investment back. You can take your interest or reinvest it into more loans. If you diversify your maturities between the three to five year terms and continue to invest across all terms, you will have access to your principal as they mature. A secondary market for P2P loans has opened up which allows you to sell your loans to willing buyers if you need access to your principle. Otherwise, your money becomes available in as little as three years. Similar to CD laddering, If you continue to invest in three-year terms, you will always have a portion of your principal coming available.
To Maximize Savings, Focus on Your Savings Rate, Not Your Interest Rate
It has been a tough time for people seeking yield on their safe money. Even as the Federal Reserve begins to raise short-term rates, the respective yields on savings accounts, money market accounts, and CDs are still relatively low. While it’s important to have your money working as hard as it can for you, finding that extra yield may not be as important as you think. Instead of focusing on your interest rate and whether you can earn a measly half a percent more, you should focus on your savings rate. In the long run, you can’t really control what your money will earn, but you can control how much money you save.
With planning and discipline, it is easier to increase your savings rate from 10 percent of your income to 15 percent. However, it is more difficult to increase your return from 1.5 percent to 2 percent without taking on additional risk. And, for all your efforts, you don’t really gain that much. For example, say you earn $60,000 a year. If, after depositing $5,000 in a money market account yielding 1.5 percent, you save 10 percent of your income ($500 a month) you will have $70,500. If you managed to earn 2 percent over that time, you would have $72,500 – a difference of $2,000.
However, if you didn’t worry about trying to increase your interest rate to 2 percent and instead increased your savings rate to 15 percent ($750 a month), you would wind up with $102,800 – a difference of more than $32,000.
You should never underestimate the power of compounding interest, but it requires time, money, and interest for results. If you’re lacking on the interest, you need to add more money or time. Once you have accumulated significant savings, you can then turn your focus to the return, which is better generated through a diversified portfolio of investments.
Author: Andrew Rombach