Don’t automatically think “bank.” That’s only one of many choices. To find the right place to keep your savings safe, start with what you want from your money and work back. You need: (1) at least the break-even yield that you’ve just found and (2) access to the money when you need it but not a day sooner. Funds you won’t want until next year can be invested differently from and more profitably than funds you’re going to use next week.
For Savings You’ll Need Immediately
(I mean right now. Or a week from Friday. Within three months, at the very most.)
Hold this part of your cash cache to a minimum because ready money earns less interest than money invested for longer terms. I’d include only:
1. Funds that you know will be spent very soon, such as a down payment on a car you’ll buy this month or an ongoing renovation of your home. 2.2. Your permanent floating emergency fund. Don’t let this fund get too large. Keeping $10,000 in a passbook account just in case the house should burn, the world explode, or your hair drop out—is dumb. Into the dailiness of life, costly emergencies rarely fall. If one does, you can always retrieve your money from wherever you stashed it. A quick-cash fund of two months’ basic expenses should be plenty. Savings do better when stored at higher rates of return or used to reduce debt.
3. Money waiting to be invested in stocks, bonds, or real estate.
Four Places to Keep Short-term Money:
Money market deposit accounts at banks online. There’s no better place. Online MMDA accounts are handy, they’re government insured, and they pay higher interest rates than you’d get from traditional MMDA accounts in the very same banks. There’s no minimum deposit and no annual fee.
Money market deposit accounts at regular banks. You earn a floating interest rate that is loosely tied to the general level of market rates. (And I mean loosely. When other interest rates go up, banks are slow to raise the rate on money market accounts. But they drop rates enthusiastically when other interest rates go down.) You can take out money whenever you want, although only six transactions a month can be with third parties and only three of those by check. Minimum balances fall in the range of $500 to $2,500. You’ll pay a penalty if your account drops below the minimum. (You may find no minimum at a few banks but probably a higher fee.)
The downside? The low interest rate. It rarely meets the break-even test. Your savings may lose value after counting inflation and taxes. If the bank charges fees, you’ll lose even more. The only hope of maintaining your money’s purchasing power is to search out an institution that pays high interest rates on money market deposits. Do it by checking "100 Highest Yields" at Bankrate.com (www.bankrate.com) or, BankingMyWay.com (www.bankingmyway.com). During the credit crunch of 2008–2009, bank money market accounts often paid higher rates than their nearest competitors, money market mutual funds.
Passbook accounts. These pay even less than money market accounts. Skip them unless you’re below the minimum for a money market account and want to stay with a traditional bank.
Money market mutual funds. Money funds offer a somewhat better chance of breaking even. In normal times, the average fund pays around 0.5 percentage point more than the average bank money market account when interest rates are low and as much as 3 percentage points more when rates are high. During the credit crunch, however, banks often paid more.
Like any other mutual fund, a money fund is a basket of various types of securities in this case, low-risk investments that earn short-term interest rates. The Securities and Exchange Commission (SEC) limits taxable money funds largely to U.S. Treasury securities, insured bank certificates of deposit, and top-grade commercial paper (short-term loans to creditworthy corporations). Tax-exempt money market funds, for people in higher tax brackets, invest in the short-term securities of states and municipalities, and local authorities that maintain sewers, water, and so on. All these investments usually mature within a brief time—a day, a week, three months, six months.
In theory, money market mutual funds are worth $1 a share, all the time. They don’t rise in value in good markets or fall in bad ones. They generally credit you with dividends daily (and pay them monthly), passing along whatever the fund is currently earning. Your minimum investment: $2,500 or $3,000, depending on the fund. Some require $5,000 or more. You can write an unlim¬ited number of checks on the fund, generally for a minimum of $250 or $500. A few process $100 checks. You pay no penalties for low deposits, although many funds will cash out your shares if your balance falls below a certain minimum, such as $500 or so.
But . . . money funds, including the money funds sold by banks, don’t carry federal deposit insurance. So although the funds are extremely safe, they’re not perfectly safe. In 2008, the giant Reserve Primary Fund got stuck with worth¬less commercial paper from Lehman Brothers, an investment bank that suddenly failed. Share values at Primary dropped to 97 cents a share—a shock called "breaking the buck." Investors fled similar money funds and didn’t return until the U.S. Treasury stepped in to offer temporary insurance.
Back in 1989 and 1990 some corporations defaulted on their commercial paper, posing a potential loss to a few money funds. In 1994 a sharp rise in interest rates damaged a handful of funds invested in the riskiest sort of derivatives—complex investments whose market value isn't always clear. No one lost money. Those funds were sponsored by large financial institutions that dipped into their pockets to make investors whole. Reserve Primary wasn’t owned by a financial institution and couldn’t make good. I still think that money market funds are safe enough, but only if they’re owned by major institutions that can afford to support the $1 price.
From MAKING THE MOST OF YOUR MONEY NOW by Jane Bryant Quinn. Copyright © 1991, 1997, 2009 by Berrybrook Publishing, Inc. Reprinted by permission of Simon & Schuster, Inc.
