As inflation has climbed, the Federal Reserve has raised interest rates to try to slow down the economy and keep inflation under control. This has raised the overall level of interest rates and that can be both positive and negative. On the downside, the interest rates on loans such as for cars or home mortgages have risen significantly making the cost of borrowing much more expensive. On the bright side, the interest rate earned on various savings accounts has also risen significantly and people can once again earn a decent amount of interest on their excess cash.
A common question is: What type of savings/investment option should I consider for cash reserves?
Let’s review some of the investment options for cash reserves.
| Checking Accounts | Savings Accounts | High-Yield Savings | CDs – 1 Year |
Money Market Funds | Treasury Bills – 1 Year | Short-Term Bond Funds | |
| Interest Rate | 0.07% | 0.40% | 3.90% | 1.59% | 4.80% | 5.12% | 4.88% |
Source: Rates are average for the category from BusinessInsider.com as of May 24, 2023. The Short-Term Bond Funds rate is the Morningstar category average as of April 30, 2023.
This is the most basic type of account to hold cash and typically provides the lowest interest rate. But these accounts also provide the most convenient access to your cash for spending.
We always recommend that people keep their bank balances below the FDIC (Federal Deposit Insurance Corporation) insurance limits which are currently $250,000 per depositor, per insured bank. This means that if you have deposits in a single bank that total $250,000 or less, your deposits are fully insured by the FDIC in the event of a bank failure. If you have accounts in multiple banks, each account would be separately insured up to the $250,000 limit. Additionally, there are ways to increase your FDIC coverage beyond the standard limit. For example, you can potentially increase your coverage by holding accounts in different ownership registrations such as individual accounts, joint accounts, retirement accounts, and certain types of trust accounts.
CDs are financial instruments offered by banks and credit unions that allow individuals to deposit funds for a fixed period at a specified interest rate. CDs are time deposits because the funds are held for a predetermined term, typically ranging from a few months to several years. Some CDs pay interest periodically (such as monthly or annually), while others accumulate interest until the maturity date when it is paid along with the principal.
The benefit of CDs is that they typically offer a higher interest rate than checking or savings accounts. However, the downside is that during the term the funds are locked, and early withdrawal may result in penalties. CDs are often insured if offered by banks that are backed by the FDIC.
Some banks offer “teaser” rates on CDs for a certain period to attract depositors to their bank. So, it can pay to compare CD rates at different banks if you are willing to put in some effort.
These are savings accounts offered by some online banks or financial institutions that provide higher interest rates compared with traditional savings accounts. The rates can range from 1% to 3% per annum, depending on the institution and current market conditions.
High-yield savings accounts offered by FDIC-insured banks in the United States are backed by the Federal Deposit Insurance Corporation. Unlike some other types of investments or savings vehicles, high-yield savings accounts provide relatively easy access to funds. Most accounts allow individuals to make withdrawals or transfer money online, through ATMs, or in person at bank branches. However, there may be limitations on the number of monthly transactions or a minimum balance requirement to maintain the higher interest rate. Since most of these accounts are offered online, you must also be comfortable with online banking.
Money market funds invest in short-term, lower-risk debt securities such as Treasury Bills issued by the U.S. government or commercial paper issued by corporations. They can also invest in short-term municipal notes issued by states and local governments which are exempt from Federal tax. It is wise to compare the interest rates offered on the taxable funds with those that are Federally tax-free to determine the highest after-tax rate based on your tax bracket.
A money market fund is a mutual fund that invests in short-term securities while a money market account is a product that banks or credit unions offer to customers that typically earns a higher rate of interest than a standard savings account. Perhaps the most important difference between money market funds and money market accounts is that money market funds are not insured by the FDIC while money market accounts are FDIC-insured.
Money market funds attempt to maintain a stable value of $1 per share but on very rare occasions they have fallen below that and “broke the buck.” These funds are highly liquid and can be sold daily with the money typically being available for withdrawal in one business day.
T-Bills are short-term debt securities issued by the U.S. Department of the Treasury to finance the government's short-term borrowing needs. Treasury Bills are considered one of the safest investments available because they are backed by the full faith and credit of the U.S. government. Of course, that security has come under scrutiny lately with Congress once again arguing over raising the debt ceiling.
Treasury Bills have a maturity period of one year or less, with three common maturities: 4 weeks (28 days), 13 weeks (91 days), and 26 weeks (182 days). They are typically issued at a discount to their face value, which means that investors purchase them at a price lower than the face value and receive the full face value at maturity.
Treasury Notes have longer maturities compared with Treasury Bills. They typically have maturities ranging from 2 to 10 years, although the specific maturities can vary. Unlike Treasury Bills, which are sold at a discount, Treasury Notes pay periodic interest to investors, usually semi-annually.
Interest earned from Treasury Bills is subject to federal income tax but exempt from state and local income taxes. The downside to Treasury Bills and Notes is that while they are highly liquid and can easily be sold, they could sell for less than their face value if sold prior to their maturity date.
Short-term bond funds are mutual funds or exchange-traded funds (ETFs) that primarily invest in a portfolio of fixed-income securities with short maturities. These funds are designed to provide investors with a relatively stable income stream while minimizing interest rate risk associated with longer-term bonds.
Short-term bond funds have relatively short durations, typically ranging from one to three years. Duration is a measure of a bond fund's sensitivity to changes in interest rates. Shorter durations imply less sensitivity to interest rate movements, which can make these funds less volatile.
These funds invest in a variety of fixed-income securities, including Treasury bonds, government agency bonds, corporate bonds, municipal bonds, and asset-backed securities. Again, it is wise to compare the interest rates offered on the taxable funds against the municipal funds to determine the highest after-tax rate based on your tax bracket.
Short-term bond funds are generally liquid investments that can be sold daily. However, the value of the shares may fluctuate based on changes in interest rates and the performance of the underlying bond holdings.
As you can see, each of these savings vehicles offer certain advantages and disadvantages. Many are offering very attractive rates right now providing a great opportunity to earn substantial interest on your cash reserves. In particular, money market funds are offering relatively high interest rates and provide stability and daily liquidity. If you have excess cash in your bank account, you might want to consider one of these higher-paying alternatives.