money market funds

Get Ready to Manage Your Bank (and Other Cash) Accounts

Philip Brewer — Fri, 22 Mar 2013 09:48:38 +0000

For most of the last five years, there's been no reason to pay much attention to how you stored your cash — it doesn't earn enough interest to worry about. That's about to change. (See also: Managing Your Short-Term Money)

Back in the 1980s, it made a big difference where you held your money. Bank interest rates were capped at below the rate of inflation. The money market fund was invented to get around that, meaning that finally, ordinary people (not just the wealthy) could get a market rate of interest on their short-term cash.

Interest rates were high enough that it made a real difference. For much of the first half of the 1980s, it was possible to get 11% on your cash — about double what you could get in a savings account, and infinitely more than you could get on a checking account (because banks weren't allowed to pay interest on checking).

With rates that high, people found it worth their while to do quite a bit of micromanaging of their money. They'd rush to get any new cash earning interest at the earliest opportunity. They'd shift any spare cash into their money market fund even if they knew they'd move it to their checking account in just a few days. They'd delay paying their bills until the last possible moment.

At 11%, a $1,000 deposit is going to earn $2.12 every week. Multiply that (and compound it!) over the course of a year, and pretty soon you're talking real money.

Before, people kept liquidity balances mostly for convenience. If you had some money sitting in your checking account, it meant you could pay bills when they came, rather than having to wait until you got your paycheck.

After, liquidity balances were a profit center.

That's good in a sense. (Profit!) But it was also yet another thing that had to be managed. It could be very unhandy if you were caught suddenly needing your money while it was in the midst of being moved.

With interest rates so low, we've been able to just ignore this.

That's what I've been doing. I mentioned a couple years ago about how the sneaky bank almost got me when they increased minimum balances. Without really giving it much thought, I just boosted the amount I kept in my account. That's been fine so far. The extra interest I could have earned by making sure that money earned a top rate is just a few dollars a year. But once rates start to go up, it's going to be a different story.

Enjoy the luxury of just keeping cash anywhere that's handy — checking account, savings account, money market account, and money market fund — without monitoring rates. Pretty soon you'll have another thing you'll need to manage.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

The Types of Savings Accounts: Which Is Right For You?

Matt Bell — Mon, 06 Aug 2012 10:36:42 +0000

Stashing money into a savings account isn’t a whole lot of fun, especially with today’s interest rates barely registering a pulse. However, we all need money set aside as an emergency fund and for short-term goals, so here are your options. (See also: 37 Savings Changes You Can Make Today)

Traditional Savings Account Options

In the past, when most people thought about places to park their savings, they thought about these four options.

Basic Savings Account

This type of savings account typically requires the least of you — just a small opening deposit and a low daily balance. In return, of course, it typically gives you the least. For example, Chase is currently paying one one-hundredth of a percent interest no matter what your balance. No, that isn’t a typo. On a $1,000 balance, you’ll earn a whopping 10 cents after a year.

Money Market Account

This type of account may require a bit more from you, such as a slightly higher opening deposit and daily balance. In return, it pays slightly higher interest, but we’re still talking about super small amounts. Sticking with Chase as an example, its money market account is currently paying five one-hundredths of a percent on balances below $10,000. Sure, that’s five times better than its basic savings account, but you’ll still only earn 50 cents on your $1,000 after a year.

Money Market Fund

This is a mutual fund, offered by brokerage companies such as Fidelity and Vanguard. Such funds usually have fairly hefty minimum initial investment requirements, such as $2,500 for Fidelity's Cash Reserves money market fund and $3,000 for Vanguard's Prime money market fund. While money market funds are typically very safe, they do come with some slight risk of loss since they have no FDIC protection.

You would think that with a higher opening balance requirement and more risk would come more return, and that has been the case with money market funds in the past. However, today’s money market funds are paying pretty much the same as the most basic bank savings accounts. In fact, Fidelity’s Cash Reserves money market fund is paying exactly what Chase’s basic savings account is paying, so right now there is no advantage to a money market fund.

Certificate of Deposit

CDs are less liquid than money kept in a savings or money market account since you usually have to opt for at least a one-year term in order to beat the rates offered by savings accounts. If you take the money out before the term is up, most CDs charge a fee equal to a number of months’ interest. While the interest rates on CDs are a little more favorable than savings accounts right now, they’re not much more favorable. Consider a CD only if you truly won’t need to access the money before the term is up.

Options for Better Rates

If you’re intent on earning a little more on your savings, here are some options to consider.

Online Banks

Their lower cost of doing business is one key reason why online banks are able to offer better interest rates. Bankrate.com lists some online banks offering one percent interest with no minimum balance requirement. After a year, a $1,000 balance would earn you a more respectable $10.

Most online banks are FDIC insured (but check to be sure), and some offer another key benefit for savers — the ability to specify goals for your savings. In most cases, you only need one actual account, but you can earmark portions of the money in the account for specific purposes such as an upcoming vacation.

Credit Unions

Because credit unions are not-for-profit organizations, they, too, usually offer better rates than brick-and-mortar banks. While membership is often restricted to employees of certain organizations, an increasing number of credit unions are loosening their membership requirements. The Credit Union National Association can help you find a credit union near you that you may be able to join.

High-Interest Checking Accounts

These accounts are all the rage right now since savings account interest rates are in the tank. Just be sure to read the fine print. You will probably have to use your debit card a certain number of times each month and maintain a relatively high minimum balance.

And here’s the main watch-out — keeping savings in a checking account can defeat the purpose. It’s just too easy to spend money sitting in a checking account. It’s usually better to keep emergency fund or short-term goal money in a separate savings account.

While there isn’t much money to be made from your savings these days, keep in mind that the main benefits you need from a savings account are safety and accessibility. At least those benefits are still readily available.

This article is from Matt Bell of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Managing Your Short-Term Money

Philip Brewer — Tue, 28 Jul 2009 12:00:08 +0000

It's easy to find books and articles on how to manage your money to support your long-term goals. You can read a lot about stocks and bonds, retirement accounts, investing in gold, real estate, options and futures. But managing your day-to-day spending money tends to get short shrift. Here's a primer.

There are three big reasons to hold cash: Liquidity, short-term goals, and emergencies.

Liquidity

You need a certain amount of money on hand just to pay your bills. People whose bills are small and predictable can actually get by with very small liquidity balances--a student living in a dorm with a meal plan, for example, might only need to carry a liquidity balance big enough to keep him in sodas and pizza.

If you've got a handle on your expenses, it's very easy to figure out what you need for a liquidity balance: It's the total of all the money you need to spend between now and the next time you'll get some income.

Most people's expenses vary from month to month--you need less in spring and fall when you're not running the heat or the air conditioner, but you need more for the months the property taxes and insurance payments are due. You can, if you want, adjust your liquidity balances to match.

My wife and I actually do that. Each month we know pretty accurately what our bills are going to come to: We know which months things like insurance bills need to be paid and we keep track of how much we've charged on our credit cards. Pretty much everything else except the electric bill is the same every month. Each month we figure out what we're going to have to pay out and make sure there's enough in the checking account to cover it.

Most people don't bother--they just carry a liquidity balance that's big enough to handle their expenses in any ordinary month. Especially when interest rates are low, there's no problem with this. (When you can earn a significant return on your savings, there's a real cost to having money sit idle in your checking account. Right now, not so much.)

Short-term goals

While your budget should cover all your regular expenses--including things like tax and insurance bills that come just once or twice a year--there are things that you'll want to spend money on that aren't so regular. Still, except for emergences, most of the other things that you'll need cash for are nevertheless broadly predictable. You should have a plan for them, whether you structure it as part of your budget, or just as a list of stuff you want.

A homeowner knows to expect (and gradually set aside money for) a new roof, furnace, air conditioner, appliances, carpets, repainting, and so on. Even though many of these expenses won't be incurred for ten or fifteen years, they're still expected. A car owner can include routine maintenance in the regular budget, but knows that an old car may need major repairs--and will in any case eventually need to be replaced. More broadly, everyone has things that they want--a vacation, a motorcycle, a musical instrument, a really good camera, a boat, the complete works of L.L. Zamenhof--that they're intending to get in the next few years.

A few of these things may be medium- or even long- term goals--if you're not planning on buying them anytime soon. Roughly speaking, I'd call anything that you don't expect to spend any money on for 5 years a medium-term goal, and anything that you don't expect to spend any money on for 10 or more years a long-term goal.

Money to support your medium- and long- term goals can be invested for the long term--in fact, much like you invest for other long-term goals, such as retirement. For short-term goals, though, you should mostly stick to cash.

Emergencies

Your liquidity balances cover your expected cash needs from paycheck to paycheck. Your emergency fund covers any unexpected cash needs--either unusual expenses (the water heater goes out and needs to be replaced) or a drop in income (your employer cuts your hours or lays you off).

The usual rule of thumb is that you should have 3 to 6 months expenses in your emergency fund. (For an analysis of why and a look at some special cases, see my post Figuring the size of your emergency fund.)

How to do it?

First, figure out how large your liquidity balance needs to be, and get that much money into your checking account. Then, each time you get paid, put enough money in the checking account to cover your budgeted expenses. If you find it more convenient to keep a larger liquidity balance, you can just put in an average amount each month (and then adjust once or twice a year). Or, if you prefer, you can figure out exactly how much your bills are going to be and pay in exactly that amount. Either way works fine.

Second, top up your emergency fund. If your emergency fund is smaller than it ought to be--either because you had an emergency and spent some of it, or because it's never been as large as it should be--pay any surplus money you have after paying your bills into the emergency fund.

Third, direct any remaining cash into whatever account you use to save for your short-term goals.

That's really all there is to it. You can fund your longer-term goals at any point along the way:

Before (through payroll deduction into your 401(k), for example),
During (such as by sending money to a mutual fund at the same time you pay your bills),
After (by accumulating savings until there's enough to buy 100 share of some stock you like).

Pick any combination of those methods that seems like it'd work for you. (Just don't pick none of them.)

Where to keep your cash

There's no need to get fancy about your short-term money. All you really need is a transaction account of some sort for paying your bills. If it pays a good rate (and you're the sort of person who can keep track and not spend money just because it's there), you could even keep your emergency fund and your short-terms savings there as well.

Most people prefer to have separate savings accounts for their emergency fund and the savings that they're accumulating for specific goals. A savings account at your local bank is fine. An internet savings account may pay a better rate. A money market fund is also a good choice.

To the extent that you know that you're not going to use the money for a period of time (college savings, for example) you can put the money into CDs or short-term bonds with a maturity date that matches when you're going to need the money.

It may be worth it to allow a bit more complexity to creep in. For example, I keep half my emergency fund in my local bank and the other half in the form of two 6-month treasury bills with maturity dates 3 months apart. As long as I have no emergencies (or only small emergencies), I roll over each treasury bill as it matures. If there's an emergency, all I have to do is nothing and each maturing bill will pay a quarter of my emergency fund directly into my checking account. (At the moment I'd probably earn a better rate with that money in CDs at my local bank, but the setup has been so convenient, I've left it alone for now.)

I also recommend that you keep some amount of cash on hand in the form of actual banknotes, even if you usually use credit or debit cards even for small purchases. There are some problems where the best solution is real cash money. Especially with interest rates as low as they are right now, there's no reason not to have some on hand. Think of it as part liquidity balance, part emergency fund.

It's still all your money

There are lots of reasons to divide your money up into multiple accounts--the retirement accounts have tax advantages, the mutual fund accounts give you access to specific investments, this or that bank's savings account pays a higher rate, and so on. The fact remains, though, that it's all your money: your entire portfolio is a single unified pool of assets that supports all of your goals--retirement, buying a boat, paying tuition, your summer vacation, etc.

Some people like to have a bunch of sub-accounts where they accumulate money toward specific short-term goals. I understand the inclination, but I suggest that you don't do this. Instead, choose where to save and invest based on the planned timeframe of the purchase. Your long-term goals should be supported by long-term investments like stocks and bonds, your medium-term goals with things like intermediate-term bonds, and your short-term goals with savings or short-term CDs. You really only need one savings account to save up the money for all the things you want to buy in the next year or two.

It's worth thinking about it correctly right from the start for this reason: While it doesn't make much difference when you're dealing with short-term cash, understanding this is critical for managing your long-term investments, especially the ones in retirement accounts, which is the topic of my next post: Optimize your 401(k).

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Why invest in the stock market?

Philip Brewer — Mon, 27 Oct 2008 12:24:01 +0000

The conventional reason for investing in the stock market--perhaps offered with a bit less confidence now that we're in the midst of a stock market crash--is, "It offers higher returns." But that gets us ahead of ourselves. We can learn a lot by taking a couple of steps back and looking first at our financial goals.

Most people have a long list of financial goals, starting with things like paying the rent, putting food on the table, keeping the lights turned on, and so on. Work your way down the list and you get to things like replacing the old car, buying a house, putting the kids through college, and (sooner or later) retiring.

Most people's wants, if you list them all out like that, will exceed their expected lifetime earnings (even before including the Ferrari, apartment in Paris, yacht, and private jet). And that's why people so automatically shoot for investments that offer the maximum returns--outsized returns are their only hope of satisfying all their wants.

That thinking, though, leads people to make all sorts of poor choices.

As a thought experiment, imagine someone whose wants could be comfortably satisfied by his or her income. (Since wants tend to expand without limit, I admit this is a bit tricky, but give it a try.) Such a person wouldn't need to invest at all (beyond establishing an emergency fund). In fact, investments would only make sense in the context of some particular goal--leaving a legacy for example.

I'd like to suggest that this is really true of everyone. You just lead yourself astray if you line up all your wants on one side, and then create an aggressive portfolio on the other, hoping for some big wins to bridge the gap between your income and all the stuff you want.

Note that I'm not suggesting that you target particular investments to specific goals--that's definitely the wrong approach. Your entire investment portfolio supports all your goals. Rather, the defect is in letting your wants grow without bound, putting you in a situation where the sum of your income and the return to ordinary saving still doesn't add up to enough to satisfy them.

Now, it's fine to have some out-of-reach desires. (For example, I'd like to have a private rail car, which although much cheaper than a private jet, is still likely to be forever beyond my means.) The problem is letting them get out of control in a way that distorts your entire investment strategy.

My suggestion is that you classify your wants into the important ones and the unimportant ones--and that the portion of your portfolio that's going to fund the important ones needs to be conservatively invested.

Lots of people have made the point that the stock market is no place for money that you expect to need in the next 5 years. The events of the past year suggest that maybe an even longer period is in order. If you're prepared to delay your retirement by 5 or 10 years in order to have a shot at retiring 5 or 10 years early, then an aggressive investment strategy may be in order. The same sort of thinking is probably not appropriate for your college savings or the down payment on a new car.

Here are some thoughts on some specific categories of investments:

Cash isn't much of an investment--but it's what you actually need when you're ready to spend. Your emergency fund should be in cash (money market fund, high-rate savings account, t-bills, etc.).
Short-term bonds rarely yield much more than cash--but they're a good choice for money that you're going to need at some particular time in the near future. (For example, as your kid approaches high school, it might make sense to start moving his college savings into short-term bonds with maturity dates that match the tuition bills.)
Long-term bonds are very vulnerable to inflation, but can be a great investment when the coupon is high enough to provide a good return over whatever inflation turns out to be.
Inflation-adjusted bonds are an excellent investment, except when the after-inflation return is very low--which it had been for the past several years. Happily, the return on TIPS has surged in just the past few weeks, making these an investment well worth considering. (They are vulnerable in a deflation, which is probably why the return has shot up.)
Gold is a store of value. There's good reason to hope that your investment in gold will maintain its value, but little reason to hope that it will grow in value. (Although the gold price will go up if there's inflation--and just staying even with inflation can be tough with other investments. Still, don't expect a return from gold that will fund any of those wants on your list.)
Stocks are the classic investment. Prices are down right now, but the looming recession will probably mean that profits will be low as well. If you've got a 10-year time horizon, stocks are a good choice.
Real estate is another classic investment, but be careful not to delude yourself. As an investment, your home is worth whatever it lets you avoid paying in rent. Properties that you rent out are definitely investments--but being a landlord is as much like having a second job as it is like owning an investment like stocks or bonds.

To answer the question I started with, the reason to invest in stocks to earn a higher return is that it lets you satisfy wants that you couldn't otherwise afford. But those higher returns come with higher risks--risks that mean that maybe those wants won't be satisfied at all.

As recent events have made clear, the average return for the stock market may be higher than the average return of most other investments--but that doesn't mean that you can plug the average return into your plans and have any expectation that you'll get that return in any particular year. Even if you have a long time horizon, stocks may be down right when you're ready to spend the money.

I guess you don't need me to tell you that.

Do some thinking about your wants. A shot at high returns in the stock market makes good sense for funding some of your wants--especially the less important ones (the sports car) and the longer-term ones (early retirement). But for the important ones, and the ones with shorter time horizons--arrange to cover those without relying on outsized investment returns.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Update on money fund guarantee program

Philip Brewer — Mon, 29 Sep 2008 15:40:58 +0000

The key thing to know about the Temporary Guarantee Program for Money Market Funds that the Treasury announced 10 days ago is that it only guarantees the money that you had in the money fund on that date. Any money you have in the fund that exceeds your balance on September 19th is not guaranteed--those shares are only worth their net asset value.

I posted when the Treasury announced the guarantee plan. Now the Treasury has released the details, in the form of a press release and an FAQ.

The plan was created for a simple reason: Money funds are key buyers of commercial paper and jumbo bank CDs. If shareholders in money funds chose to switch to more secure assets, the money funds would have no choice but to sell those assets--and if that happened to all money funds at once, there'd be no buyers. The result would have been a sudden collapse in the value of what had previously been the safest non-government assets.

With that in mind, the odd structure of the guarantee plan makes a certain amount of sense. They don't want to get into the business of guaranteeing money funds. Doing that would have a pernicious effect on the incentives of money fund managers. (Currently they compete on safety and yield. If all funds were equally safe--guaranteed by the Treasury--they would only compete on yield, driving fund managers toward the riskiest allowed investments.)

Now, though, it is only old money that's equally secure in all money funds. Any new money will only be as secure as as the assets of the fund, meaning that anyone looking for a place to put their money still needs to focus on safety. That should work to keep the incentives of the fund managers properly aligned.

Two other points:

The plan is temporary, initially in place for just three months, it can be extended by the Secretary of the Treasury for up to one year.
The plan only applies to money market funds that choose to join and pay a fee. The Treasury says to contact your fund to learn if they're participating in the program. (Individual investors can't sign up for the program individually.)

Whatever money you had in a money fund 10 days ago is as safe as any investment can be in these troubled times (assuming your fund participates in the plan). For any new cash that you'd like to put away for the future, picking a money fund will require the sort of research you should have been doing right along.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Deposit insurance for money funds

Philip Brewer — Fri, 19 Sep 2008 12:12:23 +0000

Early this morning, the Treasury announced deposit insurance for money market mutual funds, provided that the fund pays a fee. The money to provide the insurance will come from the Exchange Stabilization Fund (the government account holding the profits that the federal government realized when they seized everyone's gold in 1934).

According to the Treasury's press release, the program is supposed to be temporary, lasting one year.

Personally, I think this is a terrible idea. Money funds complete on two issues:

Return
Security of principal

There's a certain tension between those two, with extra return always entailing extra risk to principal. If the principal is insured, the incentives will shift--all funds will be secure, so they'll only be competing on return. That will push fund managers to invest in the riskiest assets that are allowed, which is a sure strategy for trouble ahead.

[Update 29 September 2008: The Treasury has released details on the program.]

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Money lost in money fund

Philip Brewer — Wed, 17 Sep 2008 03:08:46 +0000

For thirty years, people have treated money funds as being just as safe as a bank. On the rare occasions when money fund management made a bad investment, they've voluntarily coughed up enough money to make investors whole. Today, though, the money market mutual fund The Primary Fund (part of The Reserve Funds) announced that its shares, normally worth $1, were only worth 97 cents.

The fund held $785 million dollars in debt securities issued by Lehman Brothers, which the funds trustees have decided are probably worthless. In a press release dated today, the fund announced, along with the 97 cent share price, that they were also restricting withdrawals:

Effective today and until further notice, the proceeds of redemptions from The Primary Fund will not be transmitted to the redeeming investor for a period of up to seven calendar days after the redemption. The seven-day redemption delay will not apply to debit card transactions, ACH transactions or checks written against the assets of the Primary Fund provided that any such transaction from an investor, individually or in the aggregate, does not exceed $10,000.

Obviously, they concerned about their ability to sell their other investments (the ones that aren't worthless) fast enough to satisfy the customer's demands for cash.

Money market funds are invested in securities that are supposed to be not only extremely secure, but also extremely liquid, so that measure is almost as worrisome as letting the share price drop below $1.

As an ironic tidbit, the Reserve Fund is the company that invented the money market mutual fund.

What does this mean for your money market fund? I'm afraid it's impossible to guess. I expect over the next few days, all your banks and funds will be issuing press releases. Most of them will be talking about how your investments with them are completely safe. Perhaps a few others will have to admit that they lost significant amounts of money in investments with Lehman Brothers (or whatever firm is the next to go under).

Personally, I'm not yanking my money out of my money market funds. But part of the reason for that is that I've got that money divided up between a couple of different funds, and I also have chunk of cash in banks with FDIC insurance.

Update 19 September 2008: The Treasury announces a program to insure money market mutual funds.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

To Tax or Not To Tax: That Is The Money Market Question

Kate Luther — Sat, 03 May 2008 17:09:42 +0000

As America’s love affair with self-investing continues to grow, so does our fascination with tax-free accounts. Don’t believe me? See for yourself. The next time you’re in a conversation, try working the words “tax free” into your conversation and watch the ears perk up. Admit it. We despise taxes. We loathe them. So much so in fact, that Uncle Sam made not paying those taxes a crime. So the idea that we can legally earn a buck without sharing it with our dear old uncle is well, deliciously criminal.

But as WiseBread investors know, what’s good and tax-free for one investor isn’t always the right choice for another and this holds true with all your investing venues, right down to choosing a money market fund.

Most money market funds are taxable and invest in things like Treasury Bonds and CD’s but there’s also a decent selection of tax-free funds that invest in the short-term obligations of tax-exempt entities such as your local government. While the yield from these tax-free investments are a bit lower than their taxable counterparts, any return you receive is typically exempt from our friendly Uncle Sam.

So which is better?

To determine the right investment for you, you need to take the tax issue out of the equation. Your taxable versus your tax-free as it were and luckily, there’s a pretty easy formula to help you make your decision.

Tax-free yield / (1.0 – your tax bracket) = Tax-free equivalent

So, let’s say we’re considering two funds: a taxable fund that pays 2.5% and a tax-free fund that pays 2.0%. If your tax bracket is 20%, your equation is going to look like this:

2.0 / (1.0-.20) = 2.5

In this instance, the tax-free equivalent is 2.5%, the same yield as your taxable fund. But lower the tax bracket to 15% and the results work out a little differently:

2.0 / (1.0 - .15) = 2.36%

That’s a .14% less return than the taxable fund. But what if you increase your tax bracket to 25%?

2.0 / (1.0-.25) = 2.67%

Now the tax-free fund is clearly the better choice, all other things (like expense ratios and investment selections) being equal.

Of course, neither of these investments will be your key to retiring early and realistically, a one-year CD is currently offering a higher return than MMF's. But that's not always the case and as we know, a good portfolio is one with some diversification.

The bottom line? Know how to get the most from your investing dollars which, after all is what smart investing is all about.

This article is from Kate Luther of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: