CHICAGO — If the crazy ups and downs in the stock market these days have you feeling a little dazed, you have lots of company. For many savers and investors, trying to find a safe haven for whatever cash is left in their portfolios has become a top priority. Unfortunately, investing cash these days is no less daunting than investing in the stock market.
If you have a brokerage account, there’s a good chance that your broker has recommended that any cash in your account be swept automatically into a money market fund. These so-called “sweep” accounts currently hold billions of dollars — money that is probably doing a lot more good for the brokerage firms than for their customers. Money market funds, on average are paying about 0.03% interest (that’s three one-hundredths of 1% — a paltry $30 interest per year for every $100,000).
Most banks offer money market deposit accounts, which are similar to money market funds but differ in several important ways.
On the surface, money market funds and money market accounts would seem to be reasonable places for storing cash, especially for cash that may be needed on short notice. Both types of accounts permit immediate access to your money with no penalty for early withdrawal, and some offer no cost-check-writing privileges. Despite these conveniences, there are a number of things you should keep in mind if any of your cash is sitting in either type of account.
MONEY MARKET FUNDS
Don’t expect your broker to tell you, but many brokerage firms offer more than one type of “sweep” money market funds, and the one you are enrolled in may not be the best for you.
Wells Fargo, for example, offers several such accounts, one of which is a tax-exempt fund. Ironically, both the default taxable fund and the tax-exempt fund are currently paying exactly the same interest rate. While today’s interest rates are almost non-existent, it makes little sense to pay taxes when all it would take is a phone call to switch.
In another example, E-trade is currently paying 0.05% on its default sweep account. A customer holding $100,000 in that account would earn just $50 per year in interest, while a customer holding the same amount in the same company’s Sweep-Max account would be earning $500 per year in interest — 10 times as much.
Keep in mind, too, that money funds offered by brokerage firms and mutual fund families are not FDIC insured.
MONEY MARKET ACCOUNTS
For nervous investors, most (but not all) money market deposit accounts offered by banks are FDIC insured. Of course, this extra degree of safety comes with a price; bank money market accounts pay even less interest on average than money market funds.
Also on the negative side, money market deposit accounts usually require a minimum balance, and permit a limited number of transactions per month. If you allow your account to fall below the minimum required balance, or you exceed the limited number of transactions, you may be required to pay a penalty.
Both types of money market accounts have the advantage of liquidity. You have access to your money whenever you want it. However, both are money losers when you factor in inflation. With today’s interest rates calculated in the hundredths of a percent, money stuffed under a mattress may not seem like such a bad idea after all.
CERTIFICATES OF DEPOSIT (CDs)
For anyone sitting on cash and wondering how best to invest it without exposing it to the scary risks of the stock or bond markets, CDs are another reasonable alternative.
When you buy a bank-issued CD, you are lending your money to the bank for a specified interest rate and for a specified period of time (maturity date) that can be anywhere from three months to five years. While most CDs are purchased directly from banks, they can also be bought through brokerages. CDs issued by FDIC-member banks are among the safest of debt instruments because the FDIC insures them.
While current interest rates on CDs are still anemic compared to historic levels, they are generally higher than those paid by either type of money market, depending on how long it is to maturity; the longer the maturity, the higher the rate.
Perhaps the biggest disadvantage of CDs is that your money is off-limits until the CD matures. If you must have immediate access to your cash, you may redeem the CD before maturity, but you'll likely pay an early withdrawal penalty.
So, what to do with your cash? Some financial advisers recommend a combination of money market-type accounts and CDs. With this approach, you would first decide how much cash you need to keep available for immediate access. That amount would go into a money market.
The balance would take advantage of the higher interest rates from CDs. By breaking up that total into several CDs with staggered maturity dates about six months apart (called laddering), you would ensure that some part of your CD investment is never far away.
Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult an accountant or tax adviser for advice regarding your particular situation.
Have a question or comment? E-mail our editor Dave Davis at [email protected].