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Where do you put your money when you are saving for a goal that is between one and five years out?
If you watch my Instagram stories, you may have seen my vacation savings updates. My vacation savings is a short-term goal which I plan on using in one to three years. Many of you have asked about my decision to invest in mutual funds, so today I want to go into a little more detail.
For the last seven years, I have worked at a financial firm, which means I am the employee of a broker-dealer firm. With my employment comes certain perks. One of those perks is called the broker/RIA net asset value (NAV) privilege. I'm able to purchase Mutual Fund A shares without the sales charges or standard management fees.
Why is this important? With investing, you want to get reasonable returns without sacrificing the goals you want to reach. For most people, the NAV privilege is not a possibility.
Investing can be costly due to account fees, management fees, and trading fees. These costs can quickly eat into your return and negate the entire advantage of investing. It's important to remember, that with short-term savings, you don't have the time to ride out the market corrections.
For me, it makes sense to invest for my short-term savings goals because I get the benefit of a higher return without the high costs of investing (I don't have to pay up-front sales charges to purchase the mutual fund, but I am still subject to market volatility). I also don't mind taking on a little more risk for a greater reward. My vacation savings goal is flexible.
What if you don't have access to the NAV privilege like I do? Is investing for short-term savings goals (emergency fund, house down payment, or a car replacement) a smart idea?
Here's my thought on it.
The answer depends on your unique situation and goals. So today, I wanted to give the pros and cons of some different options so that you can make the best decision for your own goals.
First, let's talk about some important guidelines when it comes to saving for a short-term goal.
- The savings rate is much more important than the rate of return. If you are in the beginning stages of saving and don't need the money soon, the rate of return (what you earn on your money) doesn't play a huge factor. Mom and Dad Money shows a great example that illustrates this point perfectly.
- If you plan on spending the money in less than a year, regular savings accounts or money markets are generally better than investing. This is especially true if your goal is definite and you have a concrete time frame.
- You don't have to choose to do one or the other. You can do both. If your goal is more flexible (like a house down payment) where you don't need the money on an exact date or need a particular dollar amount, you can invest some of your money and save the rest.
SAVINGS ACCOUNT
Some people hate stashing their money in a savings account. It's easy to feel like you're not making progress when you are not earning a ton of money. It kind of feels like it's just sitting there doing nothing. I get that.
However, there are times where a savings account makes more sense. With a regular savings account at your local bank, the average return is 0.06% APY. That seems low, but you get the benefits of:
- Safety: You can save money knowing you are not taking on any risk.
- Security: If you have an FDIC-insured account, the Federal Deposit Insurance Company insures up to $250,000, per depositor for each ownership category. This protects you in case the bank fails
- Access Funds Easily: Transfer funds to another account, withdrawal money at any time, or make multiple deposits without incurring fees. Make sure to check if your account has a transaction limit.
HIGH-YIELD ONLINE SAVINGS ACCOUNT
If you want a higher return than the average 0.06% APY, you might want to look at high-yield online savings accounts. Online banks have lower overhead costs because they don't have to pay for physical branches. That means they can pass the savings to the consumer by offering higher rates.
You can set up automatic deposits to make the habit of saving routine. It can be challenging to save money, so take the willpower to spend out of the equation by setting up weekly or monthly automatic deposits from your checking account.
When shopping around for an online savings account make sure to check the excessive withdrawal fee. The money you are setting aside for a short-term goal shouldn't be used for everyday purchases. Federal law limits the number of certain withdrawals and transfers from online savings to a combined total of six per calendar month per account.
Here are some online savings accounts that offer competitive interest rates, no monthly fees for maintenance, and no minimum requirement:
- Discover Online Savings Account = APY: 1.90% (as of Sept. 23, 2019)
- Synchrony High Yield Savings Account = APY: 2.00% (as of Sept. 23, 2019)
- Barclays Online Savings Account = APY: 2.00% (as of Sept. 23, 2019)
- American Express High Yield Savings Account = APY: 1.90% (as of Sept. 23, 2019)
Other high-interest online savings accounts to consider:
- CIT Bank Online Savings Account = minimum $100 deposit monthly, APY: 2.20% (as of Sept. 23, 2019)
- UFB Direct Online Savings Account = minimum $10,000 deposit to qualify for APY: 2.25% (as of Sept. 23, 2019)
I currently take advantage of the First5 Savings Account at my local credit union, STCU. With First5, I am able to earn 5.09% APY on the first $500 in my savings account. I keep around $400 in my savings account there for small emergencies like unexpected hospital visits for my son or unplanned birthdays or events. If you have kids, then you know these unexpected costs appear way more than what we like to admit. Once your savings account goes above $500.01, the APY drops to .15%.
MONEY MARKET ACCOUNTS
A Money Market Account (MMA) is very similar to a savings account. The most significant benefit of an MMA account over a savings account is that the interest rates and terms are usually better.
The main difference between a savings account and an MMA account is what the bank can do with your money once you deposit it. When you put money into a savings account, the bank is restricted to making loans with your cash. However, with an MMA account, the bank can actually put your money into low-risk investments such as certificates of deposit, money market mutual funds, or government securities.
Money Market Accounts are best used for substantial savings. For example, let's say you have been saving for a while now. You have accumulated a nice little pile of money and are looking for a place to stash it and earn some interest. That's where a Money Market Account comes into play.
Usually, MMA accounts require a much higher minimum deposit. When shopping around, make sure to look for one with the best rates and no monthly fees.
CERTIFICATES OF DEPOSIT
A certificate of deposit (CD) acts as a savings account and has a fixed interest rate. It also has a fixed date of withdrawal, known as the maturity date.
The main difference between a savings account and a CD is the flexibility to withdraw money. With a savings account, you can deposit and take out money relatively freely. With a CD, you typically agree to leave your money alone for a specific amount of time. This is called the term length, and if you try to withdraw money during this time, you will incur a penalty.
Term lengths range from a couple of days up to a decade, but the standard length is between three months and five years. So why is the term length important? The longer you decide to leave your money in the bank without taking money out, the higher the interest rate you will earn. APYs are fixed, so your rate is locked for the duration of the term.
If you are confident that you won't need to access your savings for a more extended period (a year or more), then a longer-term CD may be the best option. The downside and one of the risks you get with CDs are that if rates rise in the coming months and years, your rate would be stuck at the fixed rate until your term ends. You might end up earning less than you might have got with a high-yield savings account.
The minimum opening balance to open a CD account is usually a little higher than a traditional savings account. When shopping around, make sure to find the best CD rates. You can open a CD account at your local credit unions, online banks, and other banking institutions.
Where are you currently stashing money for your short-term savings goal? Let me know about it in in the comments below.
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