In today’s high inflation, high interest rate environment, we are constantly looking for safe places to generate more yield with our cash. Most financial media highlight high yield online savings accounts or 12 month CDs. While these are viable risk-free options, we want to highlight additional alternative low risk investments without some of the limitations of savings accounts (e.g. withdrawal restrictions) or CDs (e.g. minimum holding periods).
What options exist besides savings and CD accounts and are not stocks or bonds?
1. Settlement Fund
If you have an existing investment brokerage account (e.g. Vanguard, Charles Schwab, TD Ameritrade), the federal money market settlement fund is a great option because the interest rate you earn dynamically adjusts with the Federal Reserve’s interest rate. Typically, the settlement account offers a higher interest rate than online banks because the banks want to earn the spread between the Federal Reserve’s rate vs. the interest they pay to you.
For example, if you compare Vanguard’s federal money market settlement fund (VMFXX) with other high-yield online savings accounts as of 1/27/23, the yield is almost 1% higher than high-yield online savings options:
- VMFXX: 4.29%
- Goldman Marcus Online Savings: 3.3%
- Barclays Online Savings: 3.4%
- American Express Online Savings: 3.3%
The other advantage vs. a high yield online savings account is that savings accounts place limits on the amount of balance eligible for interest payments. For example, Marcus only pays interest for up to $1M balance per account and $3M across all of their accounts. Meanwhile, the settlement fund does not place balance restrictions for interest payments. Additionally, the settlement fund is extremely liquid and allows you to move money in and out as many times a month. There is a minimum investment requirement of $3,000 to earn interest for Vanguard’s Federal Money Market settlement fund (VMFXX).
To summarize:
Yield: Changes with fed funds rate, but is currently ~1% higher than high yield online savings accounts and no maximum limit on the amount of capital earning interest (e.g. online savings accounts cap principal at $1M)
Liquidity: High liquidity as there are no minimum investing periods, unlike CDs which typically require no withdrawals for a fixed number of months or savings accounts which limit monthly withdrawal transactions
Restrictions: Minimum investment required of $3,000 for Vanguard
Capital Risk: Low risk because these funds are required to maintain a neutral balance
Taxes: Interest is taxable at the federal and local state levels
2. Municipal Bond Money Market Funds
If you live in a high income tax state (e.g., NY or CA), then consider municipal bond money market funds. These funds must maintain the principal balance of the investor’s deposit and may generate tax-exempt interest payments. Please note that each fund may vary, but if you select a fund for your home state, then it’s likely that the interest payments can be up to 100% tax-exempt. This is very attractive if you are a high income earner.
Separately, both the Federal Reserve’s interest rate and the cash inflows and outflows for the specific fund affect the interest distributions. One example in NY includes VYFXX (Vanguard New York Municipal Money Market Fund). This fund provides 100% tax-exempt income to New York residents from both federal and NY personal income taxes. Some of the restrictions include a $3,000 minimum investment requirement and an expense ratio of 0.16%.
To summarize:
Yield: Changes with fed funds rate, but is typically lower than money market settlement funds
Liquidity: High liquidity as there are no minimum investing periods, unlike CDs which typically require no withdrawals for a fixed number of months or savings accounts which limit monthly withdrawal transactions
Restrictions: Minimum investment required of $3,000 for Vanguard
Capital Risk: Low risk because these funds are required to maintain a neutral balance
Taxes: Interest may be 100% tax-exempt at the federal and local state levels depending on the specific fund
3. I-Bonds (aka Inflation-indexed bonds, Series I savings bonds)
The U.S. government sells I-Bonds to investors to preserve the purchasing power of their cash with inflation. Investors buy these bonds at face value and they are backed by the U.S. government’s full faith and credit. I-Bonds offer a total return that is comprised of both a fixed interest rate and the consumer price index in order to protect investors’ spending power. Investors receive a fixed rate of return at the moment of purchase, and this rate is honored throughout the duration of the bond. The rate of return is also modified every six months to account for variations in the inflation rate.
Buy I-Bonds directly from the US Treasury via a TreasuryDirect account. The US Treasury allows I-bond purchases for up to $10,000 each year with a minimum investment of $25. The Series I Savings Bond’s current interest rate is 6.89%. (for savings bond issued November 1, 2022 to April 30, 2023). I-Bonds are held in the investor’s account for a maximum of 30 years and are taxed on the federal level but not on the state or municipal levels. Your I bond may be cashed in or redeemed as soon as 12 months have passed. I-Bonds may be an attractive option for long-term investors to preserve their purchasing power.
To summarize:
Yield: Fixed rate of interest + variable rate that changes with inflation; the variable rate changes every six months
Liquidity: Minimum holding period of 12 months before allowing redemptions to cash in the bond
Restrictions: Maximum investment of up to $10,000 per person per calendar year in electronic bonds and $5,000 in paper bonds
Capital Risk: Low risk because these funds are required to maintain a neutral balance unless you cash-in your i-bond early. Given that you can only redeem your i-bond after 12 months, you may stand to lose the last three months of interest if you cash it in before 5 years. After 5 years, there is no interest penalty.
Taxes: Interest is subject to federal income tax, but is exempt from state and local income tax. If you use the bonds to cover college tuition and related fees, you may be able to avoid paying federal income tax
Consider parking your excess cash in these low-risk options for more interest, while maintaining liquidity. When deciding between these options, consider your personal financial situation in terms of liquidity, risk and taxes to see which options might make the most sense for you. Please remember that these payouts may change based on the Federal Reserve’s interest rate and therefore, monitor the Fed’s actions closely!
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