Parking Cash: Forget the Mattress
Kelly K. Spors
Jan 16, 2006
In recent years, where you parked your cash hardly mattered: Record-low interest rates kept the yields on all cash-like investments pretty uninspiring.
It's time for a wake-up call.
Thanks to a string of 13 Federal Reserve interest-rate increases since June 2004, investors can now earn substantial gains by being more proactive with their cash holdings. Some investors are still letting their cash idle in bank or brokerage accounts earning less than 1%, even though the yields on many cash investments are poking above 4%.
"People have really felt that cash was an afterthought," says Peter Crane, vice president and managing editor of iMoneyNet, a Westborough, Mass., financial-information company. "But that's starting to change." Savvy investors are "realizing they can gain a lot by putting more thought into where they're keeping it."
Taxable money-market funds recently yielded an average of 3.68%, up from 1.6% at the beginning of 2005. Yields on money-market bank accounts recently averaged 0.76%, while three-month certificates of deposit now average about 3.45%. Many six-month certificates of deposit and even some online savings accounts are offering yields of 4% or higher.
Choosing the right haven for such liquid assets is trickier than just picking the highest yield, though. It means weighing that return against other factors such as liquidity and risk.
Money in the Bank?
Consider the differences between money-market mutual funds and the money-market deposit accounts offered by banks. Bank money-market accounts are insured by the Federal Deposit Insurance Corp., and thus are extremely safe. But they tend to yield less than money-market mutual funds. Funds carry no FDIC insurance because they're not bank products, but they very rarely lose principal, because they're invested in relatively safe instruments like Treasury bills and CDs.
Money funds are also less restrictive than bank accounts, which often require minimum deposits and limit withdrawals. The PayPal unit of eBay Inc., for instance, offers a money-market fund with no minimum investment and unlimited withdrawals. Investors might also consider tax-free money-market funds, which invest in tax-exempt entities, so no income tax is due on the interest earned. Tax-free funds tend to do better when interest rates are low. Investors can compare their yields with those of taxable funds by looking at the tax-free funds' tax-equivalency yield, says Mr. Crane of iMoneyNet. Investors in higher income brackets are often better off with tax-free funds, he adds.
To land even better yields with little risk, investors may consider setting up an online savings account. EmigrantDirect.com, a unit of Emigrant Savings Bank of New York, and INGDirect.com, owned by ING Groep NV of the Netherlands, recently offered online savings accounts with annual yields of 4% and 3.8%, respectively. One advantage of online savings accounts: Most require only a $1 minimum balance. Some online money-market accounts also offer yields close to 4%, but often they require minimum balances of at least $1,000 to $5,000.
One disadvantage of online savings accounts is that most don't provide check writing, so you forgo some liquidity. But customers often can link an online savings account to a checking account and electronically transfer money back and forth, usually within 48 hours.
Hot CDs
Investors willing to tie up their cash for several months at a time might consider six-month or one-year CDs, which currently yield up to around 4.9%. Jumbo CDs, which typically require deposits of $95,000 or more, can provide even better returns. CDs with a term of one year or less "are very attractive" right now because their yields are better than shorter-term options but they don't require investors to lock up their money for too long, says Greg McBride, senior financial analyst for Bankrate.com, a financial-information site based in North Palm Beach, Fla., and owned by Bankrate Inc.
Keep in mind that penalties are steep if you need to tap a CD before its maturity date. Banks commonly charge three to six months of interest as an early-withdrawal penalty, depending on a CD's term. So CDs only make sense when you're sure you won't need the money before their term is up.
There are other reasons, too, not to commit your cash for too long a term. Kimon Daifotis, chief investment officer of fixed income for the Charles Schwab Investment Management subsidiary of San Francisco-based brokerage firm Charles Schwab Corp., suggests that individual investors now stick with investments that lock up money for less than a year. His reasoning: Most analysts expect the Fed to nudge interest rates higher one or two more notches early this year, so yields on short-term investments will probably keep rising in the meantime. Once the Fed stops raising rates, then it may be time to look at longer-term options.
What's more, Mr. Daifotis says, the differences between short- and long-term interest rates have virtually disappeared, meaning investors gain little by opting for lengthier terms such as five-year CDs over shorter ones.
Mr. Daifotis says investors willing to take on a little more risk and a little less liquidity might consider investing in an ultrashort bond fund or commercial paper. These still carry minimal risk, because they invest in securities with short maturities, but historically have had better yields than money markets. Commercial paper, an unsecured note issued by a corporation to finance its short-term credit needs, is typically only available in denominations of at least $25,000.
In looking for a place to put your cash, there can be major advantages to shopping around at various financial institutions. The same types of investments can have very different yields at different places, and you may find that a bank or brokerage firm has more than one investment option that suits your needs -- with enough of a difference in yields to seal your choice. Web sites such as Bankrate.com and iMoneyNet.com can help you find and compare the going yields on various cash investments.
For instance, so-called sweep accounts, used by brokerage firms for holding customers' cash between transactions, still often yield less than 1%. But that money often can be stored instead in higher-yielding cash investments with the same brokerage firm. Or some brokerage customers -- especially those with big balances -- may be able to select a higher-yielding sweep account.
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