In general, people should strive to have an emergency that covers 3-6 months of living expenses. These funds should be held in a liquid account that can be easily accessed in case of a sudden emergency or unexpected expense. However, not all savings accounts are created equal. If you’re not earning much in interest on your cash you are losing purchasing power as prices continue to rise. In the environment we are in now, with inflation being as high as it is, you are losing money if you are sitting on a large pile of cash in a bank account. There are places where you can put your money that offer better interest rates without taking on the risk of investing in the market, and we will also touch on some that are extremely conservative that may be of interest as well for folks that have money in brokerage accounts.
Savings Account
Despite rising interest rates over the last year, your local bank or credit union where you have your checking account and mortgage hasn’t changed their savings account rates. This is arguably a better option for your cash compared to sticking it under your mattress, but that’s not saying much.
Current Yield: 0.03% – 0.1%
Pros:
- Easy and convenient if you have other accounts at that institution
- Liquid (money can transfer almost instantly in many cases)
- FDIC insured up to $250k
Cons:
- Not even close to competitive interest rates
- Sometimes banks/credit unions have minimum balance requirements to avoid fees or to get the best interest rates
High Yield Savings Account
Online banks and large financial institutions typically offer savings accounts which have much higher interest rates compared to brick and mortar banks and credit unions.
Current Yield: 4.25% (no minimum balance) – over 5% (with minimum balance)
Pros:
- Liquid (money can transfer to an account at another institution typically in 1-2 business days, near instant if account is at the same institution)
- FDIC insured up to $250k
Cons:
- Sometimes banks have minimum balance requirements to avoid fees or to get the highest interest rates
- Rates can change at any time
- No brick and mortar presence in many cases
Money Market Savings Account
Your local bank or credit union offers these and the rates vary widely based on your account balance. They offer as little as 0.12% if you have less than $10k and up to 3.5% if you have over $250,000 in the account.
Current Yield: 0.12% – 3.5%
Pros:
- Liquid
- FDIC insured up to $250k
Cons:
- The highest interest rates may require astronomical balances, and even then you likely can get a higher rate with an online savings account with no (or much lower) minimums.
- Rates can change at any time.
- There are generally restrictions on the number of transactions you can have in this type of account. While it’s technically a checking account, you are generally restricted by the number of transactions you can have without fees and it doesn’t function like a normal checking account.
Where is the best place to keep cash for short term savings?
Going beyond your emergency fund, you might have some cash set aside for other short term expenses like property taxes or an upcoming home remodeling project or maybe a wedding. You want to invest these funds in a way that is going to be safe, but also provide a small return. There are several options for where you can keep your cash where it isn’t subject to market risk, but you are still earning some amount of interest to combat inflation.
Certificates of Deposit (CDs)
You can get CDs through your local bank or credit union or from a broker. They have maturity dates ranging from months to years.
Current Yield: 0.3% – 5.25% depending on length to maturity and whether you go through a bank or broker. It pays to shop around!
Pros:
- Not many. You likely can get higher interest rates on a savings account compared with shorter duration CDs without locking up your money.
Cons:
- Illiquid (money is locked up until maturity, you could pay a penalty to access your funds before the maturity date).
- Low interest rate at shorter maturity issues.
- Often require a minimum balance to get better rates.
- Reinvestment rate risk: when CD matures, if rates go down you will be reinvesting at a lower rate, and many CDs automatically will roll into a new CD at maturity that may not have the most favorable terms in the new one.
- Interest is taxable both at the federal and state level.
Treasury Bills
Treasury bills are issued directly by the U.S. government and can be bought by creating an account at treasurydirect.gov. They are issued with maturity dates ranging from 4-52 weeks. These are a great option for funds you know you need on a specific date (like property taxes at the end of the year or a home remodel project next year).
Current Yield: 5.4% – 5.5%
Pros:
- Interest isn’t taxable at state or local level
- High rate of return without taking on market risk
- Low minimum investment ($100)
- No cost to purchase or hold
Cons:
- Illiquid (money isn’t as accessible until the bill matures).
- Reinvestment rate risk: when bill matures, if rates go down you will be reinvesting at a lower rate
Treasury Bonds and ETFs
Many brokerages offer the ability to purchase individual treasury bonds directly. Most of the time you would buy bonds that are offered on the secondary market, meaning that they aren’t new issues. The brokerage should have a “yield to maturity” listed on the bond and as long as you hold it to maturity, you should get this rate.
You can also buy an ETF that owns a variety of treasury bills or bonds. ETFs are held in a brokerage account and traded like a stock. While this option is subject to market risk, it’s very low due to the underlying holdings being U.S. treasuries, particularly if you are focused on buying short term securities. A word of caution – intermediate and long term treasury ETFs can be quite volatile if interest rates move quickly.
Current Yield: 4.77% yield to maturity as of 10/30/2023 on BIL, an example of a 1-3 month treasury ETF. A one year treasury bond at time of writing is 5.44%.
Pros:
- Low minimum investment
- Liquid (can sell the fund at any time), though treasury bonds may not be as liquid as a treasury holding ETF
- No need to reinvest the funds when the bonds/bills mature
- Don’t need to create a separate account if you already have a brokerage account
- Interest isn’t taxable at state or local level
Cons:
- Carries an expense ratio to own ETFs and there could be a markup at certain brokerages for treasury bonds
- Subject to market risk
- Is valued every day at current value, which will fluctuate
TL DR (Bottom Line): If you need liquidity, a high yield savings account is the way to go. Best rates by far with the least amount of strings. This is where your emergency fund should probably be.
If you are willing to lock up your money for a short period of time, you can get more yield. Do it with treasury bills which pay higher interest and are non-taxable at the state level, or if you have a brokerage account you can consider ETFs or treasury bonds. CDs just don’t make sense given the other options available in my opinion.