There are better investment plans than sticking cash under your mattress. Photo by Ty Carlson on Unsplash
What a difference a year makes. Last May I was encouraging readers to never make investment decisions on emotion and to stick to their plan. Sticking with it is hard to do when stock and bond values drop significantly, as they were last year. Borrowing rates were also starting to climb, inflation was soaring, and one-year US Treasury bills were only yielding about 2%. It felt like there was no safe place to turn.
One year later, the stock market is up nearly 13% year to date, inflation is slowly cooling down, and interest rates remain high. High rates are a drag for borrowers, but it’s a huge boon for anyone buying a CD, money market fund, or other fixed income products, which I’d like to talk about today.
The market turbulence of last year motivated a lot of investors to reduce investment activity. In some cases this meant putting less money into their 401ks or other retirement accounts. In other cases, it meant keeping excess cash and savings in their checking accounts.
This “flight to safety” is understandable, but it has missed two important considerations. First, inflation eats away at dollars more quickly that are earning less interest. Second, climbing interest rates present opportunities for low-risk investment gains that may go missed.
Here are three cash or cash equivalent types of investments you may want to consider to capture some of these higher interest rates we’re experiencing, rather than keeping cash stashed under your mattress (or checking account).
CERTIFICATES OF DEPOSIT
While checking and savings accounts are yielding well under a half percent per year, many banks are offering Certificates of Deposit, or CDs, at much higher rates. In many cases these are paying over 5% per year.
What’s the catch? Not much. CDs are a deposit product with a fixed term, meaning you need to leave your money there for a period of time. Your money isn’t locked away, but withdrawing it before the term is up could result in modest penalties in the form of withheld interest. Interest payments are typically monthly, quarterly, or at the end of the term.
One gotcha to watch for: CDs may be callable. This means you receive a guaranteed amount of interest, but this can be cut short by the CD issuer “calling” the CD early, in which case you receive your initial deposit back prematurely without any further interest payments.
An important benefit of CDs is they carry the same FDIC insurance your checking and savings accounts do, up to applicable limits. “Safe” money in a CD is the same as “safe” money in your checking account in this sense, but in exchange for your money being tied up for a period of time, the bank is willing to pay substantially more interest.
Who CDs are good for?
Because of the penalties that may be imposed for early withdrawal, you should typically only invest in a CD when you’re confident you won’t need your cash before the CD term is up. Still, the penalties imposed on the loss of some interest accrued aren’t significant.
MONEY MARKET FUNDS
Another way to earn significantly more interest on your cash is with money market funds. These are mutual funds that invest in a variety of short-term, high-quality debt instruments like US government or corporate securities.
Money markets are unique in that their value, unlike other mutual funds, does not vary over time. The value remains at $1 for each mutual fund “share” you own. The fund then pays an amount of interest, typically monthly, which can go up and down over time as rates change.
What about FDIC insurance? Money market funds aren’t bank deposits so they lack this protection, but they tend to invest in highly liquid, short-term, historically risk-free assets.
Who are Money Markets funds Good For?
Many money market funds are currently paying nearly 5% interest per year. With no penalties for early withdrawals, money market funds may be best suited for those who unexpectedly need their cash withdrawn for other purposes sooner than later, or who are unsure how long of a CD term they can commit to.
TREASURY BILLS
Treasury bills, or t-bills for short, are debt obligations issued by the US Treasury. They have maturities of one year or less. You put your money in and when the investment matures you get your money back plus interest. T-bills are also paying rates on par with CDs and money market funds, to the tune of 4 to 5% per year.
Are t-bills insured? T-bills are not deposit products sold through a bank, so they lack the explicit FDIC insurance coverage; however, they are issued by the US Treasury and are backed by the full faith and credit of the US government, a government that has never defaulted on its obligations in history. In this way, most investors view t-bills as carrying the same “guarantee” as bank deposit products, since the FDIC is implicitly backed by the US government as well.
Who are t-bills good for?
T-bills provide a guaranteed rate of return for a fixed period of time, similar to CDs. While CDs have FDIC insurance limits, there is no limit to the amount of t-bills you can purchase, implicitly receiving the same protection since they’re backed by the US government. There are times when t-bill rates are better than CD rates with the same term, or vice versa, so this can present some opportunities. T-bills cannot be purchased through your bank, but you must either open a brokerage account or an account directly through the US Treasury on www.treasurydirect.gov to purchase them.
I hope this article has helped you consider ways to put your cash to work. Interest rates haven’t been this high for decades. While that’s hurting borrowers, lenders are benefiting. Find ways to become a lender! This is best done by moving excess cash from a checking or savings account into a bank deposit or investment product like a CD, money market fund, or t-bill.