Where to Park Short Term Savings
If you've been read some of my articles on investing, you may have come to the conclusion that index funds are the best place to invest savings. If that's the case, why put money anywhere else?
The truth is that there's no such thing as the best. It all depends on what your needs are and how much risk you're comfortable with.
THE REASONS WHY
Security: If you need the money within five years or so, you can't afford to keep it in stocks, since if it goes down when you need it, you're stuck. By selling the stocks and putting the money elsewhere, you can profit off stocks along the way and have guarantees when you need the money.
Target-date funds automatically shift your money over to a more secure investment when you're within five years of your goal.
Short-term savings: Emergency funds and annual expenses shouldn't be put in an index fund, as you may need to access the money quickly.
Retirement: If someone is living off the returns of their retirement account, it makes sense to keep the money in a high-yield savings account or somewhere else that would offer similar security and gains.
Bottom line: If someone needs to keep money in a secure place where they can access it at any time but still wants to ensure its steady growth, stocks aren't the place to do it. There are other options.
Bonds
Unlike a stock, a bond isn't a piece of a company. Instead, when you purchase a bond, you're really lending money to the company and will be paid back with interest.
How much? It depends on who the issuer is and when the bond will mature-i.e., when you can cash it in and receive your money back. A bond can mature in less than a year or in 30 years.
Unlike stocks, one common place people receive bonds from is governments, both local and national. Both governments and companies are rated by different companies on their stability (like a credit score). Obviously, if a company goes bankrupt, the bond is worthless, which is why many people purchase bonds from the US government, making their investment essentially risk free.
US Treasury bonds tend to be the safest, but accordingly, they offer the least interest, while municipal bonds are backed by the local government and are somewhat less safe. Corporate bonds, on the other hand, contain much more risk, since the company can fail or just be unable to pay, but they can produce much better returns.
There are also bond index funds, which contain a range of bonds, providing diversification without the need to look at individual bonds; those are a great option too.
OTHER OPTIONS
CDs (certificate of deposit): These generally offer the highest interest rates of the following options. The downside? The money is usually locked up for a set time period, making it a poor choice for an emergency fund.
High-yield savings accounts/money markets accounts: High-yield savings accounts are a good place to keep an emergency fund or savings you may be living off of. However, you can't use a debit card or checks connected with the account; you need to transfer the money to a checking account to use it.
Money market accounts are similar but usually offer checks and sometimes even debit cards. They're both FDIC insured up to $250,000.
Money market funds: These are offered by brokerages as an investment and offer a little more interest than money market accounts. They aren't FDIC insured but are low-risk since they generally invest in low-risk investments like CDs and government and high-rated corporate bonds.
How to Choose
It depends on several factors. Timelines make a big difference, as does ease of access. An emergency fund should be kept in a place that's simple to get to.
Security is a factor-although most of the options listed are similar in that regard.
Finally, look for the one that offers the best interest. You don't need to use the money market your bank offers. Often, online accounts are just as safe and produce more interest. With large sums of money, the difference between 3.5 and 4.5 percent interest makes a big difference.
