On September 18th, 2019, the Federal Reserve cut interest rates another quarter-percent, lowering its target rate to 1.75-2%. For borrowers, this cut translates to cheaper loans and likely thousands of dollars saved in interest payments. For savers, however, yield is becoming harder and harder to find. Traditional cash savings accounts pay very little anymore. Economic woes have many savers wary of seeking returns anywhere they would have to put their principal at risk. At this point, it might seem impossible to keep cash safe and still earn a worthwhile return. Fortunately, there are options available and plenty of them. Below are some of the best places to put cash when interest rates are low.
High-Yield Savings Account
High-yield savings accounts are liquid cash savings accounts that pay higher interest rates than traditional cash savings accounts. They are typically offered by online-only banks such as Ally, Marcus, or Barclays to name a few. Online-only banks don’t have brick-and-mortar locations. As a result, they can operate on much lower overhead and pass those savings on to their customers in the form of higher interest rates.
Currently, many of these banks pay close to 2% per year in interest, which is more than twenty times the national average. Some also compound interest daily, which translates to higher earnings overall. In essence, the more often interest is paid, the more interest can compound, the greater the end result.
Prospective savers should account for the following when shopping high-yield savings accounts:
- Annual interest rate
- Interest rate compounding frequency
- Account balance minimums
- Account fees
- General accessibility (e.g., mobile app, deposits/withdrawals, transfers, etc.)
Since these banks have no brick-and-mortar locations, savers should also be aware that there can be a slight lag (typically 24-48 hours) in transferring funds to external accounts. Also, for those savers who need to pull cash out of ATM’s on a regular basis, they’ll want to ensure the online bank has an accessible ATM network so ATM fees don’t become an issue.
For those with fewer liquidity needs looking for more yield than high-yield savings accounts, short-term certificates of deposit (CDs) can be an excellent solution. CDs are the same as cash savings accounts except for the following differences:
- They typically require a minimum deposit amount that is generally higher than standard savings accounts.
- They have a fixed timeframe (aka “term”) that the funds are locked up and unavailable, and withdrawals made during this time may be subject to a penalty.
- They don’t allow for additional deposits after the initial deposit.
- They have exposure to inflation risk. CD rates may be lower than the rate of inflation.
Short-term CDs refer to terms less than 12 months, which can be particularly attractive in low-interest-rate environments. When the Fed cuts interest rates, they are generally doing so to guard against an economic downturn by provoking more borrowing and spending in the economy.
If a recession is on the horizon, it’s generally a good idea not to tie cash up for multiple years. Even if a shorter-term means earning a little bit less interest, recessions provide unique buying opportunities. If savers and investors can buy-in low, that could potentially generate much higher returns in the long run than the interest they would earn on long-term CD.
As of the time of this writing, there’s only 0.25%-0.5% difference between the best 5-year CD rates and the best 6-month CD rates. If a recession does come within the next five years, it’s hard to justify tying cash up that long for a quarter-percent more per year when better opportunities could undoubtedly come along.
Other savers may still want the better rates of longer-term CDs, but are wary of tying so much cash up for so long. CD ladders can solve this issue. With a CD ladder, rather than depositing a lump sum of money into one long-term CD, smaller amounts get split among CDs with varying terms.
For example, $50,000 is split into five $10,000 sums into a one-, two-, three-, four- and five-year CD. As each CD matures, the money is reinvested into a new five-year CD. After year five, every subsequent year after that will have a five-year CD mature. The end result is a higher return rate than a regular savings account.
CD laddering is generally a bad strategy to employ for growing retirement savings. CD interest is taxable if earned outside of a retirement account, and the long-term returns of CDs cannot compare to the historical average returns of the stock market. Additionally, penalties paid for early withdrawal can be anywhere from 60-180 days of interest, depending on the length of the CD term and the bank offering the account.
Short-Term Investment-Grade Municipal Bond Funds
For savers that need to be more tax-conscious, short-term municipal bond funds can be one of the best places to put cash in low-rate environments. They provide an opportunity to earn better interest rates than traditional CDs and receive those interest payments as federally tax-free income. However, if applicable, municipal bond interest income still may be subject to the Alternative Minimum Tax.
Municipal bonds are debt obligations issued by local governments or territories to raise funds for public projects such as building schools, roads, libraries, etc. Repayment is secured by either the taxing power of the issuer (general obligation bonds) or the revenue generated from tolls, fees, and other charges (revenue bonds). Bonds are therefore issued a credit rating that is based on their overall financial health.
Researching individual municipal bond issuances can be a tremendous headache. It can be challenging to achieve sufficient diversification and exposure if limited to only a few issuances. This is where municipal bond mutual funds come in handy.
In a fund-type structure, investors can achieve sufficient diversification with smaller sums of money. There is also less research required, as the fund creators and managers already do much of the screening for different terms and credit qualities. For an added layer of principal protection, it is generally best to stick to solely investment-grade credit qualities.
As with CDs, the short-term municipal bond funds are generally the better option in low-interest-rate environments. Not only is there less interest rate risk, but it is also much easier to hold short-term bonds to maturity. The ability to hold bonds to maturity alleviates some of the concerns around bond price movements from interest rate changes if it’s necessary to offload the holding before reaching maturity.
Nonetheless, municipal bonds generally don’t hold up as well against inflation as stocks, and there is always a chance of default. In 2013, for example, the city of Detroit filed for municipal bankruptcy and defaulted on its issuances, so investors should pay extra careful attention to the credit rating and stick to only investment-grade issuances.
Short-Term Investment-Grade Corporate Bonds
Just as local governments issue debt instruments to raise funds for projects, for-profit corporations do the same. Corporate bonds offer several benefits that savings accounts, CD’s, and municipal bonds cannot.
For one, they tend to offer much more attractive yields. Most corporate bonds are debentures, which means collateral is not put up to secure them. As a result, they are a higher-risk holding, but they pay higher interest as a result. For municipal bond issuers, this is not much of a concern because they always have their taxing power or revenue-generating power behind them.
With corporations, however, a lot more could go wrong. There could be downward industry pressures, harmful government policies, poor company management, rising interest rates, etc. The list goes on. Nonetheless, corporate bonds are also issued credit ratings as municipal bonds are, so the higher the rating, the lower the risk of default.
The second benefit of corporate bonds is their much more ample diversity. Investors can choose from a variety of sectors, structures, and credit-quality characteristics, allowing them to hone-in on the opportunities that best fit their needs.
Lastly, corporate bonds are highly-marketable. The size and diversity of the corporate bond world are much more ample than that of municipal bonds. Corporations tap into the bond market to raise more than $1 trillion in financing each year. There is also currently more than $8 trillion of corporate bonds outstanding. In other words, the corporate bond market is highly liquid, making it easier to offload corporate bond holdings before maturity if necessary. Regardless, today’s interest-rate environment still favors shorter-term holdings for interest rate risk mitigation.
The Bottom Line
While finding yield for cash savings in today’s interest-rate environment is becoming increasingly more complicated, there are always alternative options available. Finding the right fit means assessing liquidity needs and risk tolerance. Outside of FDIC-insured cash vehicles, risk and yield are directly correlated, so the higher the risk, the higher the yield. Savers should keep this fact in mind as they consider our best places to put cash. Savers should also generally stick to shorter terms to insulate themselves from interest rate risk.
For questions on our best places to put cash when interest rates are low, or for assistance strategizing a savings plan, please email us at firstname.lastname@example.org or schedule a time to chat. We look forward to connecting!
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