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Picture of Christopher A. Hopkins, CFA

Christopher A. Hopkins, CFA

Cash is no longer trash: options for short term savings

Just a year ago, one would be hard pressed to exhaust a paragraph, must less an entire column, on where to find attractive returns on cash balances. Today the landscape has changed with the Federal Reserve raising interest rates and inflation beginning to abate, providing individuals with an array of options for stashing their cash while earning a respectable return.

A general rule of thumb is to consider as short-term assets any funds that may be needed in an emergency or are dedicated to a specific expenditure within 3 years or so. Investing for more distant needs like retirement allows for a greater degree of risk in exchange for higher long-term reward, but near-term savings should be allocated to vehicles that prioritize safety and liquidity. Until recently, that has meant paltry or near-zero returns. Today the available choices are more plentiful and rewarding.

In addition, the interest rate market is in an unusual state called an inversion. Ordinarily, one would expect a higher rate of interest on investments with longer maturities, forcing savers to confront a tradeoff between liquidity and yield. Today, rates of return on shorter-term investments are considerably higher than long-term rates, a sign that markets expect interest rates and inflation to decline in future years. This inversion of yields is often a harbinger of an impending recession but presents savers with the best of both worlds in the here and now.

Thanks to the evolution of new financial products and changes in banking and securities regulation, investors have more choices today and these options are considerably more flexible than available a decade ago. The internet and online banking have also expanded the opportunity set. Here are a few of the more attractive options.

High-yield savings accounts. Forget the traditional passbook savings account. Today a variety of institutions offer accounts that pay competitive variable interest rates of 3.5% to 4.5% on deposits with relatively few restrictions. The highest yielding accounts are offered by online banks with little or no physical infrastructure and may allow for a limited number of transfers per month or even debit card access. Deposit minimums vary but many have no minimum balance and there is no fixed term.

Most of these accounts are insured up to $250,000 per depositor per bank, but you’ll want to verify the bank is covered by FDIC. Also note that fees vary, but there are plenty of no-fee options. It’s easy to shop around on the internet, more about which anon.

Certificates of deposit. These are time deposits at banks that offer a specific maturity from 1 month to several years and pay a stated rate of interest periodically, returning the original principal at maturity. FDIC-insured CDs are one of the most secure investments available if held to maturity, but usually assess a penalty for early withdrawal. Interestingly due to the yield curve inversion, rates on shorter-term CDs are materially higher than those farther out, a bonanza for savers.

In addition to CDs offered by your local bank, there are hundreds of options available through brokerage firms in what is called the secondary market. These “brokered CDs” sometimes offer more competitive returns and often include attractive features like a survivor option or “death put” that pays off the full principal and accrued interest upon death of the owner. Investors can bail out early by selling them through the broker, but are subject to market risk of gain or loss based on market interest rates changes.

Money market funds. These are types of specialty mutual funds intended to provide attractive returns on cash. While not insured, they carry relatively little risk due to the quality of their holdings and regulation by the SEC. Most brokerage firms offer their own money market funds, or you can buy them directly from any number of fund companies.

So-called “prime” funds have the richest yields and hold a mix of short-term securities like Treasury bills, commercial paper, and some corporate bonds. They are highly liquid and sport competitive yields with CDs and high-yield savings accounts, currently in the 3.5-4.5% range. You can also buy money funds comprised of US Government bonds as well as funds of municipal securities, which may be exempt from state income taxes but have lower interest rates.

If these choices seem overwhelming, there are a number of helpful resources on the web. Nerdwallet.com and Bankrate.com are excellent sites for comparison of features, rates, restrictions and fees for each of the instruments mentioned. 

Treasury securities. Perhaps the best deal on the block, for the first time in ages, is found at the US Treasury. Due to the current rate inversion, 6-month T-bills are yielding north of 5%, a full percentage point over 10-year Treasury bonds. Just 2 years ago, the 6-month bill paid a whopping 0.05%.

Treasury securities can easily be purchased through a brokerage firm, or straight from the Government on TreasuryDirect.org in $100 increments. There is a robust secondary market should you wish to sell before maturity, although you will be subject to price fluctuations as interest rates vary.

It’s been quite a while since investors had any decent options for their emergency and short-term savings. In the current environment of higher rates, declining inflation, and stock market volatility, cash is no longer trash.

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