3/1/2007

Where to Park Your Cash

There are so many places to stash your short-term savings. Here we present the resumes of the major aspirants:

Checking accounts
Checking accounts are meant for transactions, not savings. That’s why many don’t pay much, if any, interest. However, some banks do combine the conveniences of checking with the return of a money market account. Also, as “asset management” accounts at brokerages become more feature-rich — offering unlimited check writing, ATM access, and money market rates — more folks are shunning the banks in favor of brokers.

Pros

• Your money is only a check or an ATM machine away.
• A bank branch is usually not far, often in your grocery store, if you’re so old-fashioned as to want to deal with a human being.
• As with all bank deposits, checking accounts are insured by the Federal Deposit Insurance Corp.

Cons

• Depending on the bank, you may not earn much, if anything, on the money in your account.
• Many checking accounts require a minimum balance or charge fees, or both, which are a pox upon your pecuniary patience.

Savings accounts
In the old days, savings accounts — or passbook accounts, as they’re sometimes known — were the most popular rest area for short-term savings. Fortunately, folks are getting smarter and parking their pelf in higher-yielding investments. The pittance you earn in most savings accounts isn’t enough to even keep up with inflation.

Pros

• The money in a savings account is insured by the FDIC.
• Account minimums are often low.

Cons

• The return on savings accounts is so low, some mattresses pay more in interest.

High-yield bank accounts
Nowadays, you can find high-yield savings and checking accounts. They’re an ideal place to park money for your monthly bills. They offer flexibility (you can add or withdraw funds at any time) and liquidity (your dough isn’t locked in for a specific time period). Some even boast interest rates on par with more restrictive investments like CDs. The best rates by far are offered by online-only banks that keep costs low by cutting back on frills.

Pros

• Better rates than many standard bank accounts.
• Same FDIC insurance applies to high-yield accounts.

Cons

• Bare-bones banks with no ATM/debit access or check-writing privileges can be a big hassle if you need your cash fast.
• Customers must coordinate their cash flow by transferring money back and forth from the online bank to a linked checking/savings or brokerage account. That means delays — two to five days — before everything’s reconciled.
• Watch out for limited-time teaser rates by researching the product’s six-month interest rate history.

Money market deposit accounts
Money market deposit accounts are offered by banks, usually require a minimum balance, and permit a limited number of transactions per month (six transfers, three of which can be checks written on the account).

Pros

• Money market deposit accounts are very liquid. Most allow for easy access through checks, transfers, and even ATMs.
• Because they are offered by banks, money market accounts are insured by the FDIC.

Cons

• Unfortunately, you may pay for the liquidity by receiving less in return than from certificates of deposit.
• If your account falls below the minimum required balance, or you exceed the limited number of transactions, you might pay a penalty.

Money market funds
Money market funds are offered by brokerages and mutual fund families. These funds invest in highly liquid, safe securities such as certificates of deposit, government securities, and commercial paper (i.e., short-term obligations issued by corporations).

Pros

• With a money market fund, you can have the money in your hot little hands very quickly. Often, you can write checks or use an ATM card.
• The returns on money market funds are typically higher than the return on money market accounts.
• Issuers go to great lengths to keep the NAV (the price of each share of the fund) at $1, so your principal is relatively safe.

Cons

• Money market funds are not FDIC insured.
• There is no guarantee that the NAV will remain at $1.

Certificates of deposit (CDs)
CDs are debt instruments with a specific maturity, which can be anywhere from three months to 60 months (i.e., five years). Most CDs are issued by banks, but they can be bought through brokerages.

Pros

• CDs are very safe because most are offered by banks, so they are FDIC insured.
• Depending on how long it is to maturity, CDs may pay more than money markets.

Cons

• Your money is off-limits until the CD matures. If you must, you can redeem the CD early, but you’ll pay a penalty.

U.S. government bills or notes
“Treasuries” are backed by the full faith and credit of the U.S. government. Treasury bills mature in less than a year; Treasury notes mature between two and 10 years.

Pros

• Treasuries are considered the safest investments in the world.
• They can be bought directly, commission-free, at TreasuryDirect.
• They are exempt from state and local taxes.

Cons

• If you shop around, you might get a better return from money markets, CDs, and corporate bonds.
• If you need your money before the security matures, you may not get back all of your original investment.

I Bonds
No, they have nothing to do with the Internet. I Bonds are inflation-indexed savings bonds issued by the U.S. government. The amount an I Bond pays is adjusted semiannually to keep up with inflation and protect the purchasing power of your money.

Pros

• I Bonds are backed by the full faith and credit of the U.S. government.
• The “I” in I Bond protects your investment against inflation risk.
• They are sold in manageable denominations, ranging from $50 to $10,000.
• They can be bought from most financial institutions, including TreasuryDirect.
• The earnings are exempt from state and local taxes, and can be tax-free if used for post-secondary education expenses.
• Taxes on earnings can be deferred for up to 30 years.

Cons

• You must hold an I Bond for at least 12 months, and you will pay a penalty of three months’ earnings if you redeem the bond before owning it for five years.

Municipal bonds
Municipal bonds (or “munis,” as the big talkers refer to them) are issued by state and local governments in order to build schools, highways, and other projects for the public good. Municipal bonds are most attractive to high-income investors looking for tax-friendly income.

Pros

• Munis are just a step down from U.S. securities in terms of safety.
• Income is exempt from federal taxes, and might be exempt from state and local taxes if you live in the municipality that issued the bond (check on the tax implications beforehand).

Cons

• Interest from munis is relatively low. Unless you’re in a high tax bracket, you’ll usually get a better return from other investments.
• You may have to pay a commission to buy municipal bonds.
• If you need your money before the bond matures, you may not get back all of your original investment.

Corporate bonds
Corporate bonds represent debt issued by companies, from the blue chips to the “cow chips,” if you know what we mean. The more creditworthy the company, the less it’ll pay in interest. Moody’s and Standard & Poor’s rate companies as to their ability to meet their debt obligations. Only short-term bonds are appropriate for short-term savings.

Pros

• Corporate bonds usually pay more than government securities, money markets, and CDs.

Cons

• The company that issued the bond could suspend interest payments, or even go belly up.
• You may have to pay a commission to buy bonds.
• If you need your money before the bond matures, you may not get back all of your original investment.

Bond funds
Bond funds are mutual funds that pool the money of investors to buy bonds of all stripes.

Pros

• They are an efficient way to buy bonds in small increments and get the diversification that minimizes the risk that you picked a bond from a deadbeat company.

Cons

• The NAV (i.e., the share price) of a bond mutual fund fluctuates, because of interest rate movements and the bonds bought and sold inside the fund. Therefore, you’re not sure exactly how much of your original investment will be around when it’s time to take your dough. Likewise, the yield on a mutual fund fluctuates.
• You will pay an ongoing expense to own the fund, called the “expense ratio,” and you may have to pay a commission, called a “load.”

Further Reading

Money Management

Money Software

Online Money Software