If you do your banking online, you’ve probably seen advertisem*nts for certificates of deposit or high-yield savings accounts with tantalizing yields.
Rate hikes from the Federal Reserve have pushed up yields on cash while inflation has somewhat cooled, so it might be tempting to throw your money at whatever offers the highest yield. But when it comes to your cash, yields aren’t everything. What’s more, today’s higher cash yields may not last, especially if the Fed starts cutting interest rates.
Key Questions Before You Decide Where to Put Your Cash
Here’s what you should consider as you decide where to stash your cash:
- How accessible do you want your money to be?
- How important is it that your money is backed by the FDIC?
- Are there any restrictions, like a required minimum balance?
How Accessible Do You Want Your Money to Be?
A key starting question is when you might need access to your cash. If you need to get to your money quickly and easily, you should look for more liquid offerings. There are usually trade-offs between liquidity and yield, so consider what your cash is for and whether you can lock up your money in exchange for a higher yield.
Going after the highest yield isn’t always the right answer. Cash in an emergency fund should be liquid even if its yield is lower. That’s because withdrawals from an emergency fund tend to be unplanned, and you shouldn’t have to worry about withdrawal penalties when you need that cash. A general rule of thumb for working people is to hold three to six months of basic living expenses in liquid cash instruments, like savings accounts or money market funds.
How Important Is It That Your Money Is Backed by the FDIC?
The next step is to think about whether you want your cash to be guaranteed. While cash investments like money market funds are relatively low risk, you may decide that you want insurance that you’ll never lose your money. The Federal Deposit Insurance Corporation insures up to $250,000 in CDs and savings accounts, so you won’t lose your money even if your bank fails.
Are There Any Restrictions, Like a Required Minimum Balance?
Once you know your stance on liquidity and guarantees, take a closer look at the yields that different investment choices offer. Some accounts may require a minimum balance. Sometimes the advertised yield may only apply to balances under a certain level, often $15,000, and higher balances will have lower rates. In some cases, a high “teaser” rate may only apply for the first few months you hold the account before dropping.
Places to Keep Your Short-Term Cash
CDs, high-yield savings accounts, and money market funds are the best places to keep your cash when it comes to interest rates. Treasury bills currently offer attractive yields at the lowest risk. Learn how they compare in terms of yield, liquidity, and guarantees.
CDs: Higher Yields but Lower Liquidity
With CDs, you have to be wiling to lock up your money with a financial institution for a set amount of time. Banks generally pay more for the certainty that your funds will be there for a specific amount of time than they will if you could take out your cash at any time. CDs typically offer the most compelling yields of all cash instruments, and they’re FDIC-insured. Five-year CDs on Bankrate.com are yielding up to 4.50% per year, and one-year CDs are paying out up to 5.35%.
Although the current yields on CDs are appealing, there are some other factors to consider:
- CDs pay out a fixed yield over the term of the account, so the relative yield you get could be less competitive if rates rise while your money is locked in the account. (Though the opposite could be true if rates fall during the term of the CD.)
- Minimum deposits are also a potential barrier for the highest-yielding CDs, which may require $25,000 or more.
- You will have to pay a penalty if you need to get at your money before the term of the CD is up. The longer the term of the CD, the bigger the penalty for cashing out early. This lack of liquidity means that CDs aren’t a great choice for an emergency fund.
High-Yield Savings Accounts: Greater Flexibility
High-yield savings accounts generally have lower yields than CDs, but what you sacrifice in yield you receive in liquidity. Plus, you still get FDIC protection if you open an account through a bank, or from the National Credit Union Administration if you open your account through a credit union. According to Bankrate.com, the yields on some savings accounts are up to 5.25%, and many of these accounts come with check-writing privileges. While minimum investment amounts tend to be lower for savings accounts than they are for CDs, many high-yield savings accounts may require you to maintain a minimum balance. Read the fine print before you sign up.
Money Market Mutual Funds: Liquidity and Yield but No Guarantee
Like savings accounts, money market mutual funds offer daily liquidity, which means you have ready access to your cash if you need it. Unlike savings accounts, however, these funds aren’t FDIC-insured. Although they lack the guarantee, money market funds are a relatively low-risk investment. They also may have higher interest rates than a high-yield savings account: Money market funds are yielding up to 5.3%. As with savings accounts, the interest rate of your money market mutual fund may change after you purchase, so the actual return you get on the fund may be different from the yield you see advertised.
Treasury Bills: A Government Guarantee
T-bills are backed by the government, so they are a risk-free investment. You can buy them from a brokerage firm or directly from the government at TreasuryDirect.gov. T-bills don’t offer daily liquidity: The most common maturity dates are four weeks, eight weeks, 13 weeks, 26 weeks, and 52 weeks. The minimum purchase is $100 for newly issued T-bills, and they are sold in increments of $100. You could get slightly better yields on your T-bills if you buy them on the secondary market through your brokerage firm, but you may have to pay commission.
You may be able to find higher yields in a CD if you aren’t worried about having immediate access to your money. If you want daily liquidity, money market funds, which track the performance of Treasuries, or high-yield savings accounts may offer competitive yields.
The author or authors do not own shares in any securities mentioned in this article.Find out about Morningstar’s editorial policies.
