Regardless of the amount of money you have, it’s important to keep a portion of it in liquid assets that are readily accessible to pay bills and other debts. The simplest and most common way to maintain liquidity is through cash kept in a savings or checking account through a bank or credit union. However, interest rates are often poor, providing just a slightly better return than stuffing your money in your couch cushions. (You can’t count the change you find in your couch cushions as interest.)
Are there alternatives that can maintain general liquidity while providing a little better interest rate? Indeed, there are. Here are some examples.
- Certificates of Deposit – Traditional Certificates of Deposit (CDs) are savings certificates with a fixed term and fixed interest rate issued by banks, savings & loans (S&Ls), and federal credit unions. At the end of the term, you can cash them in or roll them over into new CDs. CD terms range from one month to five years, with three, six and twelve months the most common. In general, the longer the terms, the better the interest rate. Minimum amounts vary widely but they can be opened at many banks for under $1,000.
CDs have penalties for early withdrawal, but a common practice to keep liquidity is to “ladder” CDs – this means to open a series of CD’s with varying maturities such as 3, 6, 9 and 12 months so some cash is always readily available with minimal or no withdrawal penalty. When they come due, you can cash them, roll them over, change to a different term, or switch investments altogether, depending on your needs and what the market is doing.
Variations of CDs are now available including single bump-up (one change in interest rate allowed), fully liquid (ability to withdraw some money from a CD without penalty in exchange for a minimum balance), and other novel approaches. The tradeoff is usually in the interest rates. Check with your bank to see what variations are available.
CDs issued by banks and S&Ls are insured by the Federal Deposit Insurance Corporation (FDIC), while CDs issued by credit unions are backed by the National Credit Union Insurance Fund (NCSIF). The insurance coverage provided is identical: up to $250,000 for a single depositor per financial institution, and up to $500,000 for joint accounts with two depositors.
- T-bills and Savings Bonds – Treasury Bills can be purchased in standard 4-, 13-, 26- and 52-week terms, or as a cash-management bill with terms as low as several days. The minimum purchase level is $100.
T-bills are sold at a discount and then redeemed for face value at maturity. You can sell them anytime, making them quite liquid, but with returns not much better than a savings account if you sell them early. While there is functionally no credit risk with T-bills (as they are backed by the full faith and credit of the US government), there is a very small degree of market risk with 26- and 52-week bills if sold before maturity. The only way this can occur is if short-term interest rates rise sharply between the day you buy the T-bill and the day you sell it. That makes your T-bill worth a little less than new T-bills offering a higher interest rate for a similar term. In such a rare instance, you would be best advised to simply hold your T-bill to maturity.
Savings Bonds are all electronic now, available as low as $25 and up to $10,000 per year, and are easily redeemed. You do have to wait one year from purchase before redemption, and you can redeem any time after that, with a penalty of three-months interest for redeeming before five years from purchase. They can provide a backup source of liquidity in the longer term.
Both T-bills and savings bonds are government-backed, making them extremely safe investments, but returns are generally low.
- Money Market Account – These are basically glorified savings accounts that provide a little higher interest based on the current money market values. Your tradeoff is higher minimum balances and limited number of withdrawals or check writing per month. These are also FDIC-insured.
- Money Market Fund – Not to be confused with money market accounts that are bank products, money market funds are mutual funds that invest in a variety of short-term investments with terms less than one year. There may be tax advantages depending on the type of investments that the fund holds. There are no fees as with stock funds.
The main advantage of a money market fund is a good interest rate with the highest liquidity. The main disadvantage is that it is not insured by the FDIC, and it is possible to lose value. In essence, it’s like a low risk stock that is immediately liquid. Some even offer limited check-writing privileges.
These alternatives offer a variety of security and accessibility options while generally providing a significantly better return than a checking or savings account – or your couch cushions.
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