In part 1 of this article we looked at some criteria for selecting best short term savings options. These include the ease with which you can access your funds, interest rates on your savings, the level of service you can expect to get, and penalties associated with breaking the terms of your short term savings option, whether it involves going below the minimum deposit amount, exceeding the number of free transactions per month, or something else. We also looked at a few of the best short term savings options which include interest yielding checking and savings accounts, and money market deposit accounts. In this article we will continue to look at other options for short term savings.
Best short term savings options : other options
Money market funds : Money market funds invest in safe and liquid securities including government securities, certificates of deposit and commercial paper. They are offered by mutual fund families and brokerages. Money market funds are liquid and easily accessible. You often get check-writing and ATM privileges. Top money market funds also yield higher interest rates than money market accounts. Money market fund issuers take great care to keep the share price (NAV) at a dollar, which means your principal generally stays safe. However, these funds are not FDIC insured, and your NAV is not guaranteed to remain at a dollar, so you could lose some of your principal, however unlikely.
Certificates of deposit : Certificates of deposit or CDs are mostly issued by banks, but you can buy them through brokerages as well. Once you have deposited the money, you do not have access to it until the CD matures. The time to mature can range from 3 months to 5 years. Since CDs are offered by banks, they are very secure and FDIC-insured. CD savings rates can actually exceed those of money markets, depending on the time to maturity. The main disadvantage is that the money in CD savings accounts is locked away till they mature. You can withdraw the money earlier, but only by paying a penalty.
Treasury bills : Treasury bills and treasury notes are backed by the credit and faith of the United States Government. Treasury notes takes from 2 to 10 years to mature, whereas treasury bills mature in under a year. U.S. Government backed treasury bills and notes are supposed to be the safest investments in the whole world. You can buy them without a commission at TreasuryDirect.gov, and do not have to pay state or local taxes on them. On the flip side, they do not have the highest interest rates. Interest rates on money markets, bonds and CDs are often higher. Also, you may lose some of your investment if you withdraw your funds early.
I Bonds : I Bonds are issued by the Unites States Government, and are savings bonds indexed to the inflation rate. They are adjusted twice a year to stay on par with inflation, so you do not lose purchasing power. They are backed by the U.S. Government and sold in a variety of denominations from fifty to ten thousand dollars. As with treasury bills, you can buy them from TreasuryDirect.gov, and the earnings are not taxed either at the state or local level. They can be entirely tax-exempt if you use them to pay for higher education. Even when taxed, the taxes can be deferred for thirty years. However, you must hold the bond for at least a year, and you forfeit three months of earnings if you cash in an I Bond in less than 5 years.
Municipal bonds : Municipal bonds are issued by local and state governments, The revenues are used for public works projects. They are exempt from federal tax, and could be tax-exempt at the local or state level if they are issued in the municipality in which you live. However, they usually yield low interest rates, and are probably best for shielding some of your income from taxes (if you are a high earner) rather than for obtaining high interest on short term savings. You may also need to pay a commission on them, and lose part of your investment if you cash in the bond before it matures.
Corporate bonds : Corporate bonds are issued by companies, and some of them are short-term bonds, which are appropriate for short term savings. They pay higher interest rates than government-backed securities, CDs and money markets. But you could stand to lose your money if the company goes under. You also have to pay a commission to buy corporate bonds.
Bond funds : Bond funds pool investors' funds to buy a variety of bonds. By doing do, they spread the risk and minimize the chance of buying a bond from a company that subsequently fails, and allow you to buy a small number of bonds. However, the share price and yield of a bond mutual fund will fluctuate, so there is some risk involved. You will also pay an expense ratio to hold the fund, as well as possibly a commission called a load.
In the end, there is no one best short term savings option for everyone, but one or more of the options in this and the companion article should meet your needs.