In all the dismal economic data, I finally found something to be hopeful about: As unemployment rose and consumer confidence sank last year, the amount of money people saved moved steadily upward. I cheered as it climbed from 0.8 percent in April 2008 to 6.4 percent in May 2009. From August 2008 through August 2009, we collectively saved $5.6 trillion.
And the good news doesn’t stop there. I’m happy to tell you that my sources, with the exception of a few outliers, see low inflation on the horizon. “We anticipate inflation averaging about 2.5 percent a year over the next five years,” says Mark Zandi, chief economist at Moody’s Economy.com.
Suddenly we super-savers can ask the kind of financial question that’s fun to consider: What should we do with all our money?
Let’s start with what not to do with it. If, like many people, you’re saving for a time in the near future when you feel comfortable spending again, then don’t buy stocks. There is a big difference between money you’re putting away for the long term (for retirement, perhaps, a portion of which does belong in the stock market) and cash you are going to need in the next three to five years (to start a business, buy a car or pay a child’s college tuition). Short-term funds do not belong in stocks, because you can’t afford to lose money that you’ll need soon. And although the stock markets historically go up over decades, in the near term they are unpredictable, which means you don’t know where they will be when you need to withdraw.
Second, don’t put your short-term cache into savings accounts, money market accounts or traditional CDs. Balances sitting in basic checking or savings are pretty much earning you nothing, so keep only your emergency cushion in these accounts, for immediate access. The average interest rate on money market accounts today is a pathetic 0.1 percent. Even a two-year CD will net you only about 1.1 percent, on average. With payouts like these, you’ll lose money on your investment because taxes and inflation will eat away more than your entire return.
Here’s the math: Say you manage to find a one-year CD at 1.7 percent. You’ll lose about one third of the interest to taxes, which brings you to around 1.1 percent. With inflation expected to be around 2.5 percent, every dollar you have will lose that much in purchasing power each year. So even though you’re “earning” 1.1 percent after taxes, your real return is a negative 1.4 percent. A year down the road, $100 would buy you only $98.60 worth of stuff.
So where to stash your cash? The options below are meant to protect your principal and help your money grow.
High interest–bearing checking
Historically, interest-bearing checking accounts have been a big waste of time. Recently, though, some savvy financial companies have decided they can make money by offering you the chance to earn a little as well. These small to midsize banks have introduced checking accounts paying four percent in certain cases (sometimes more)—which is roughly 35 times what you can earn right now on an average checking or money market account.
Of course, there are many hoops to jump through. Take, for example, the checking account from Royal Banks of Missouri, available to anyone, anywhere, who is willing to access the account online. It’s paying 4.3 percent on balances of up to $24,999 and 1.4 percent on remaining balances above that maximum. There are no fees for the account, but you must buy something with your debit card at least 10 times a month (the bank makes its cash on the merchant fees from these transactions), make either one direct deposit into the account every month or one automatic payment out of it, and receive your statements online. If you don’t meet these rules, you earn 0.15 percent on the whole balance for that month. Because it is unlikely there’s a Royal Banks automated teller machine in your neighborhood, the account will reimburse $25 in ATM fees a month if you meet the requirements.
Is it worth it? Let’s say you maintain a $20,000 balance. In a year, you’ll earn $860 in interest. If you’re a frequent debit card user and bank online anyway, why not? These accounts have the same FDIC protection offered by any local bank. To find one that works for you, go to checkingfinder.com.
Nontraditional Certificates of Deposit
These days, the average CD isn’t worth it. A better bet is to look at introductory teaser rates (which you can find at bankrate.com) from banks looking to boost deposits with an appealing deal. “This is a very competitive market,” explains financial adviser Jonathan Pond, author of Safe Money in Tough Times. “Sometimes the CDs you see advertised are a lot more attractive than you can get locally. As long as they’re FDIC insured, you don’t have to worry.”
With all CDs, think about laddering them. Here’s how it works: Divide your money into, say, five pots, and invest the chunks into CDs that come due over each of the next five years. That way as interest rates rise (and they have nowhere else to go), you won’t have to wait a full half decade to take advantage of the higher rate; you’ll be able to roll over the CD that matures next. This strategy will also give you more access to cash if you need it. Check out the following two CD types that you might not have heard of before.
These new products are longer maturity CDs that offer an escalating return for every year you hold the certificate. They might pay one percent in year one, two percent in years two and three, and four percent in the fourth and fifth years. They are FDIC insured, and although you buy them through your brokerage firm, the issuing bank pays the commission so you won’t have to. If you want to pull your money out of these early, you’ll need to go back to your broker. Pond explains there can be a secondary market for these CDs, and your broker can (for a commission) find someone else to buy what you want to sell. “But you might get whacked on price,” he says. “If interest rates rise and you have a CD at two percent when the going rate is four percent, no one will want to buy it. So you shouldn’t buy with the intention of selling early.”
The returns on this type of CD are tied to an index (such as the S&P 500) or currency movements or inflation. You’re guaranteed not to lose money if the index goes down, which is comforting; but if it goes up, you’ll generally reap only part of the gain. For example, if the S&P goes up by 12 percent, explains Maryland-based financial adviser Susan Fenimore, you may get seven percent. This means you’re never exactly sure what you’ll be getting when you buy it; if you only break even, there’s a chance your portfolio may not keep pace with inflation. Still, you have the possibility of a greater upside return. Fenimore also notes, “The principal of some of these instruments is FDIC guaranteed, others are guaranteed by the bank. Make sure you understand what you’re buying.” Choose the FDIC option.
Short-Term Bond Funds
For Jonathan Pond, it’s simply not acceptable to allow his clients to park cash in a money market account earning well under one percent. “I just won’t let them do it,” he says. Instead, Pond directs them toward short-term funds that invest in municipal and corporate bonds; these can earn a four to five percent return. You can buy them through any brokerage firm, but as with all mutual funds, it’s a good idea to check the fund’s rating on morningstar.com. Some funds are better than others.
You also need to understand that these are riskier than the other options I’ve listed. Although bond mutual funds are less risky than stock mutual funds (and short-term bond funds are less risky than intermediate and long-term bond funds), you can lose money if bond markets go down. “It’s very rare that they’ll lose money in a given year,” Pond says. “They may not make as much as they’re expecting, but that’s a price worth paying for that four to five percent average return.”
If you haven’t already locked down your borrowing costs (fixing the rate on your mortgage and home equity loans, for example), now is the time. As I said, interest rates have nowhere to go but up; if you don’t lock in now, you’ll pay more later. Then—assuming you have cash left over after you’ve funded your six- to nine-month emergency cushion and made your retirement account contribution—pay down some debt. If you pay off a credit card debt at 18 percent, you get an 18 percent return. Pay off a mortgage at six percent, and you pocket about 4.5 percent (because you lose the tax deduction). Both returns are guaranteed. And if you’re looking for a feeling of safety and security, try sleeping in a house that you actually own.
Sidebar: Should I Buy Gold?
Gold doesn’t qualify as a risk-free way to double your returns. But if you happen to be anxious about inflation, you could keep it in your portfolio for safety. Terry Savage, author of The New Savage Number, puts it at the top of her list for protection. “What you’ll earn depends on the price of gold,” she says, but in times of crisis, “gold beats or at least keeps up with inflation.” And while the dollar stays weak—which it is expected to do until interest rates start to go up, perhaps in the second half of this year—the price of gold is likely to continue to rise.
There are two ways to buy gold. You can buy a gold-based exchange traded fund or ETF, which is traded like a stock. Or you can buy gold coins, such as American Eagles or Canadian Maple Leafs. Savage prefers the coins because she finds them less volatile. To find a dealer in your area, go to the Web site of the American Numismatic Association. Then store the coins in a safe-deposit box at a bank.
Jean Chatzky is More’s finance columnist and the author of several books. Read more of her advice here.