One question frequently arises: "can I get a better return on my savings?" If by savings we mean short-term cash that may be needed within the next two or three years, the answer is no. There are really no safe, high-yielding vehicles suitable for relatively short time periods, given the extraordinarily low interest rates prevailing today. But there are a few alternatives to a low-yielding savings account that you may not have considered that could have a material impact on your financial well being.
If you know you will need the cash soon, stick with certificates of deposit that are insured by the Federal Deposit Insurance Corp. Shop around for the best rates and then don't look back. Keep the maturities reasonably short, within the window of your expected need for the cash. If it is longer than two years, you can "ladder" or mix up several CDs of varying maturities. If you stretch out too far and need the money sooner, you will forfeit some of your meager earnings.
Consider online banks for higher yields. Internet banking is safe and reliable if you do your homework and ensure that the money is guaranteed by the FDIC, and the absence of brick-and-mortar infrastructure allows these institutions to offer somewhat higher returns.
Of course if you are carrying high-interest debt such as credit card balances, it is wise to pay off some of that debt with your cash holdings. It makes little sense to hold cash while incurring interest charges on revolving credit accounts. If you don't carry balances, you might step up other monthly loan payments such as car loans or even house payments.
If you are all buttoned up on your loans, think about getting a cash reward credit card for routine expenses. There are several low- or no-fee bank cards that offer anywhere from one to five percent cash back on your monthly purchases, depending upon the type and timing of your spending. If you routinely pay off the entire balance each month, this can easily beat short-term investments like CDs. You can generally set up most of your recurring bills such as utilities on these cards, as well as regular staples like groceries and gas. Then pay off the whole shebang each month and get a nice rebate that you can take in cash or apply toward future balances.
If you are fully participating in your 401(k), strongly consider starting a Roth IRA. Contributions to a Roth are not tax deductible, but you may reclaim any principal deposits without penalty at any time regardless of age, so the cash always is available in case of emergency. Since the earnings accumulate tax-free, this can be an excellent complement to a bank savings account up to the annual contribution limit of $5,500 ($6,500 if you are over 50). The only catch here is you must earn less than $184,000 jointly to qualify for the full contribution.
Finally, avoid the temptation to reach for yield. If your time horizon relatively is short and you can't afford to suffer a loss, stay away from higher yielding alternatives such as short term bond funds. While the risk of significant losses is small, you could easily see enough of a decline in value to erase all of your interest income and then some, particularly with interest rates at historic lows. Even a small bump in rates could cost you a whole year's earnings.
This is an excellent time to remember that potential returns are related to the risk of an investment. With short term cash that you need to count on, accept the fact that that rates are low and play it safe.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager at Barnett & Co. Investments in Chattanooga.