One of the personal finance questions that I most frequently get asked is: “where should I invest short-term savings?”.
When I dig deeper, I often find that the context behind the question is that the person asking has a short-term goal that they are saving up for (i.e. grad school, down payment on a home, wedding, vehicle, etc.), and they don’t want their savings to sit and decay, without earning a return on investment.
Because the funds will serve a specific purpose at a specific time, the goal here should be to preserve principal, while maximizing return, without risk. What type of financial account is best for that?
There is not an indefinite right answer to this question, as the answer can change over time based on various economic factors, but as of the time of publish, there are a few things that everyone should consider when deciding where to park short-term funds.
For Critical Savings, Avoid Volatile Investments Like Stocks & Bonds
If you have a critical goal amount that you need to get to (and maintain) in order to make your future purchase, you should avoid volatile securities like stocks and bonds. There is nothing worse than saving up for a big purchase, only to have the market crash right before meeting your goal. It’s just not worth the risk, when there is no guarantee that your investment will go up in value. You’ll sleep easier at night with your funds elsewhere.
Cash, Savings Accounts, Checking Accounts, and MMA’s Don’t Currently Carry Much Punch
Savings accounts, checking accounts, and money market accounts (MMA’s) are simple to use, highly liquid, and are typically FDIC/NCUA insured up to $250,000, all of which has historically made them a great vehicle for short-term investments.
However, at the time of publish, the national average rate for savings accounts is 0.09% for savings accounts, 0.08% for checking accounts, and 0.2% for MMA’s. Those are near historical lows – and, sadly, it’s been this way for many years.
The federal government pegs its measure of inflation (CPI) around 2.5% for the past year. At that rate, and current savings/checking account rates, you’d be losing about 2.3 to 2.4% of your purchasing power for each year you have your funds sitting in one of those accounts. And if you want to put cash under your mattress, you’re losing the full 2.5%.
Some “high-yield” accounts are offering north of 2% rates, but they often make you jump through more than a few hoops, such as a certain number of transactions per month, high minimum balances, direct deposit, etc.
Certificates of Deposit Are a Solid Option Right Now
Currently, and for the first time in years, certificates of deposit (CD’s), are looking like a solid option for short-term investment.
CD’s are not as liquid as savings/checking/MMA’s, but if you know that you will not need cash for a specific time period that is longer than CD terms (from 1-month up to 10 years), you’d be hard pressed to find a higher yield with less risk right now. If the issuer is FDIC/NCUA insured, your funds are protected (up to $250K). Additionally, there are no extra hoops to jump through for these higher yields, other than making the deposit and leaving it alone.
A word of warning: not all, but most CD’s will enforce an early withdrawal penalty if you withdraw funds prior to the full maturity of the deposit term. So you’ll want to be sure that you won’t need the funds prior, or you could lose money.
I’d recommend checking out the rates currently offered by your investment broker to see what time frame makes the most sense, and what the going rates are.
A quick scan of Vanguard, shows the following rates:
- 1 month: 2.00%
- 3 month: 2.30%
- 6 month: 2.40%
- 9 month: 2.50%
- 1 year: 2.70%
- 18 month: 2.85%
- 2 year: 3.10%
- 3 year: 3.25%
- 5 year: 3.55%
- 7 year: 3.55%
- 10 year: 3.60%
At current rates, and with rates expected to increase more in the near future, it looks like a CD’s in the 3-month to 1-year range would make the most sense. You don’t get a huge premium for going longer. And there is almost no premium difference between the 5, 7, and 10-year CD’s.
As always, shop around.
Where are you currently parking your short-term investments? And why?