Saving for the Short Term

Dave wrote yesterday with a common question. He’s looking for a low-risk investment with decent returns, but not having any luck finding one. He writes:

I currently have a Money Market Savings account and the interest rate has dropped to 1%. It used to be 5%. When it was earning 5%, I had roughly $25,000 in there, and would make something like $60-$90 per month in interest. Now I have $50,000 in there and only made $36 this month. I understand the economy is to blame for this, but I’m just looking for suggestions on where to keep my money. What would you do?

Dave doesn’t need the money immediately, but he’d like to keep it safe. He’s saving for the down payment on a house. To be honest, I don’t think he has a lot of options.

Risk and return are intertwined. In order to obtain higher returns — especially over a short period of time — he’d have to take unnecessary risks. The stock market isn’t a good place to put your money if you think you’ll need it within a few years. Stocks are great investments for retirement accounts or other long-term goals, but they’re too volatile to be considered for money you’ll need soon.

Expert advice
But are there options other than bank accounts? What about bonds or bond funds? For expert advice, I checked with three certified financial planners. They all pretty much said the same thing: Dave’s best option is to keep his money in an FDIC-insured bank.

Neal from Wealth Program wrote:

Bonds make no sense right now and the bank should be used to satisfy short-term and/or emergency money. I can understand why Dave is upset about low bank rates, but the solution is to be very clear on his objectives, execute the strategy that fits his financial and emotional needs, and accept the fact that all strategies have pros and cons.

Dylan from Swan Financial Planning elaborated about bond investing (a subject I’m just beginning to learn about):

Technically, you do not “keep” money in bonds. You buy a bond with cash and in order to get that cash back you either need to wait until maturity or someone else has to buy the bond from you.

In other words, your money is much less liquid than in a bank account. Finally, Carl from Behavior Gap added:

This is best addressed by Mark Twain: “I am more concerned about the return OF my money than the return ON my money.” People are making HUGE mistakes right now reaching for higher yields…Best to stay short in a money market at an FDIC-insured institution and when rates rise build a short 1-3 year ladder using Treasuries. Everyone can do this themselves. Then just be OK that you don’t have to worry about it.

Saving for the short term
If an FDIC-insured account is the best option, then there are three primary account types to chose from. I write about these a lot, but there’s a reason for that. These accounts should form the foundation of your financial infrastructure. They are:

• High-yield savings accounts. High-yield savings accounts (and money market accounts) are a great way to save, especially if safety is a priority. Interest rates are low right now, but I’ve seen some banks advertise 2-3%. And as the economy continues to improve, yields will rise.
• Certificates of deposit. CDs generally offer better yields than savings accounts, but at the cost of liquidity. You hand over your money to the bank for a set period of time (six months, two years, etc.) and in exchange they pay you a higher rate. For most folks, a CD ladder is a good way to maximize returns. Dave needs to be careful, though, that he doesn’t tie his money up too long — he’ll want to be able to access it when he’s ready to buy that house.
• Rewards checking accounts. Many small community banks and credit unions around the United States offer a special "rewards" checking account, a product administered by a company called BancVue. These accounts carry restrictions and requirements (you have to make 10-12 debit purchases each month, the rate only applies to the first $30,000 or so in your account, etc.), but if you meet them, it’s tough to beat the returns. Here’s a huge list of rewards checking accounts by state. There are still checking accounts offering 6%!

If I were in Dave’s shoes, I’d try to find a way to split the money between two rewards checking accounts. If he can get 6% on two $25,000 deposits, he’d earn $250 in interest per month instead of just $36! (This might be hard to do, though. Here in Portland, for example, 4.01% is the best rate I can find.)

Low-risk investing isn’t sexy, especially in the short term. There are no magic bullets. If there were some secret way to earn better returns without sacrificing risk, it wouldn’t remain a secret for long!

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