In January 2016, U.S. stocks posted the worst ten-day start to a year in history. And while the stock market has moved upwards, it continues to be volatile, causing some investors to be fearful about about putting their money in stocks.
If the market doesn’t align with your financial goals, or you are looking for a more conservative option, below are potential solutions for where to park your money:
High-Yield Savings Account at an Online Bank
Online banks tend to have lower expenses than traditional banks and frequently pass those savings on to their customers. These high-yield savings accounts can generate up to 1.05% annually. Note, however, that there are a few restrictions. For instance, you can only make six transactions per statement cycle, and the interest rates are subject to change. Also be cognizant of account maintenance fees, and stay under the FDIC limit of $250,000 to ensure your deposits are insured.
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While finding the right bank with the highest rate might be daunting, there are companies that can help. For free, you can search through hundreds of accounts for the highest rates on sites such as Bankrate and DepositAccounts. For a fee of 0.02% per quarter (or 0.08% a year), Max, an online banking tool, moves your short-term savings between accounts as interest rates change to ensure you are always earning the highest available rate and keeping your balance under the FDIC limit.
Certificates of Deposit (CD)
If a 1% yield doesn’t get you excited, you might consider purchasing a CD or a basket of CDs. One strategy that can help reduce interest rate risk and potentially increase overall returns is what’s known as CD laddering.
A five-year laddered CD strategy works like this: a hypothetical $50,000 investment is used to buy five $10,000 CDs, each maturing one year apart from one another. The first CD matures in 12 months, the second CD matures in 24 months, the third in 36 months and so on. The CDs with a longer maturity date will provide a higher yield than the shorter, helping to increase the overall average return of the portfolio.
When the first CD matures, the idea would be to purchase a new CD at the end of your ladder—in this case, a CD maturing in five years. With this strategy, you will always have a piece of your investment maturing within 12 months in the chance you need the proceeds for an unexpected expenditure. In addition, if interest rates on CDs happen to increase since your initial purchase, you will have the opportunity to take advantage of the new rate on each maturity date.
Short-Term Bond Fund
After savings accounts and certificates of deposit, the next step up on the risk scale would be high-quality, short-term bonds. Instead of attempting to pick a handful of individual bonds and hoping they don’t default, you might consider buying a mutual fund or index fund that holds hundreds, if not thousands, of bonds. Sure, you may lose some investment control (and potentially yield), but you also lower the risk.
A short-term bond fund typically invests in bonds that are maturing within one to three years—also known as short duration. By keeping the duration short, you are less impacted by a rise in interest rates, which could have a negative impact on bond prices.
Peer-to-Peer (P2P) Lending
While P2P lending isn’t necessarily a solution for short-term savings (and hasn’t been around long enough to be labeled as conservative!), it could prove to be an alternative to traditional stocks and bonds for some. P2P lending is exactly what it sounds like—you lend your money to consumers or businesses for an agreed-upon interest rate. Leading players in this industry, such as Lending Club and Prosper, help facilitate the loan and screen borrowers, so you can make an informed decision. Lending money to a pool of higher quality borrowers—as measured by credit score, credit history and other metrics—can result in a lower interest rate. Lending money to lower quality borrowers, who have a higher chance of defaulting on the loan, can deliver a higher rate. Many of these P2P lending sites are publishing rates of return between 5% and 30%, prior to their fee. (Lending Club charges investors a 1% service fee on each payment; Prosper collects an annual loan servicing fee of 1% of the outstanding principal balance.)
Before making an investment decision, be sure you are aware of all the risks involved and consider consulting with a financial professional for additional advice and support. With access to information, technology at our fingertips and great options for short-term savings, there’s no reason you can’t maximize your savings potential and have a healthy reserve in place.
Taylor Schulte, CFP® is founder and CEO of Define Financial, a San Diego-based fee-only firm. He is passionate about helping clients accumulate wealth and plan for retirement.
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