Wednesday, August 26, 2009

Getting the Highest Yield Today

Bert Whitehead, M.B.A., J.D. ©2009

How can you expect to make money with your money when short-term interest rates are lower than you have ever seen? Short term Treasury Bills (T-Bills) for 30-90 days pay virtually zero percent. Lock in your money for 1-2 years and you can expect 0.5% to1.0% these days. As with every investment, higher returns mean higher risks. Let’s review your alternatives.

Bank C.D.’s – There is a significant spread in yields offered by various banks. Today you will find FDIC insured banks paying 1.0 to 2.0% on 1-2 year C.D.’s. This is twice as much as Treasuries are paying, and your money is still guaranteed by the US government, right? So what’s the catch?

There are a couple of minor considerations, e.g. interest from Treasuries is exempt from state income tax but interest earned on CD’s is not. Also, if you cash in a CD early, you are charged a penalty equal to 3 months interest. A short term ‘T-Bill’ cashed in early may be sold at a small premium or discount, depending on which way interest rates move – so this is generally a small overall advantage of T-Bills.

The biggest danger with high-yield CD’s is that the best yields are generally offered by the weakest banks. If the bank fails, the FDIC moves in and takes over and usually sells it to another bank. You are guaranteed to get back the balance of your account including accrued interest to the date the bank is closed (up to $250,000 now). Normally this takes only a short time, like a couple of weeks or less. But if there are problems (bad record keeping, fraud, etc.) your money could be tied up over a year – and you are not paid any interest from the time the FDIC shuts the bank down.

There can be other inconveniences, such as ATM’s shut down, checks not honored for awhile, etc. but that would not necessarily affect you if you only have CD’s at the bank.

Money Market Funds – These funds buy very short term commercial paper (30-90 days) and have been long considered very safe as they are committed to maintained $1.00 par value ( so you couldn’t lose your principle). But a large fund (Reserve) ‘broke the buck’ last year and the net asset value dropped to $.93. This set off a panic, so the feds stepped in and guaranteed deposits up to $250,000 until Sept. (since extended…probably forever). These funds are immediately available, but are paying generally less than 0.10% -- so on $1,000 you would earn $1.00 in one year.

Municipal Money Market Funds -- These funds hold very short term municipal bonds (less than one year maturity). Many municipalities have huge unfunded pension liabilities and are facing lower tax revenues, and so are considered ‘junk bond’ quality. They are paying less than 0.25% - so they really aren’t usually worth the bother for the extra risk/reward ratio.

Short Term Muni Bonds – these pay somewhat higher yield than muni money market funds, currently around 0.5-1.0%. Usually clients don’t have enough money to diversify buying individual bonds, so diversification provided by short term muni bond funds is attractive…of course the fund passes on their expenses so the yield is less. I consider this very risky because bond funds generally add lower quality in their mix to improve their yield. These bonds are so risky that current issues are not insurable. Consider that the state of California has had to resort to sending IOU’s to their citizens for tax refunds because they don’t have enough money.

Other High Yield Offerings – We are always glad to review investment options for clients, Most of the time there is significant risk involved in these offering. Some however merit consideration. For example, Schwab Bank is offering FDIC insured savings accounts that pay 1.35% (guaranteed up to $250,000).

Obviously Schwab only offers this to its own best clients, so they aren’t tempted to switch their deposits elsewhere. So you’re not likely to see it advertized to the general public. We can provide information and assistance to client who is interested in reviewing this option.

One advantage is that you can get a Schwab Bank checking account along with it so the funds are easily transferable on-line to other Schwab brokerage accounts or by writing a check to other institutions as desired. Keep in mind however that this is likely a ‘teaser rate’ and so it may be reduced without notice.

In summary, there are few good options to invest short-term cash. Unless you have a very large sum of cash I don’t think it’s worth the bother to hop from one bank to another to chase an extra ½% for three months. We do stay on top of this for you and monthly update the ‘Cash Options’ we maintain to give clients advice on current rates. If you have any questions or concerns, please contact your Cambridge Advisor.