“Hi! I recently came into some money (about $100,000) and want to know how to save it. I don’t have any debt and have an emergency fund. I plan to buy a house in the next few years and will use some of this money. I was talking to my bank about their CD rates and they are pretty disappointing. I have a friend from college that works in the advisory field and says I should give the money to him to invest for me. When I asked about fees, he said it would be around 1.40%. What are your thoughts?
What To Do With Short Term Savings
First off Tyler, great job not having any debt whatsoever! There aren’t many people that cam make this claim. What you found out about the Certificates of Deposit is sad, but it is the environment we are in. In fact, it is exactly what I would suggest you do.
Here is why: when you invest in the stock market, you need a long term time horizon. Since you will be using a good portion of this money for a down payment in a few years, the stock market is not where you should be parking your money. With such a short time horizon, you risk losing money. The longer you stay in the stock market, the lower the likelihood of you losing money overall. This isn’t to say you won’t have down years, but in total, you will mote likely make money as opposed to lose money.
In addition to that, you would be crazy to invest you money with your friend from college for a 1.40% fee. You can invest your money with Vanguard in a few of their funds for less than 0.50%. While the difference of 0.90% doesn’t seem like much, over time, that adds up to some serious money.
Certificate of Deposit Trick
Like I mentioned above, unfortunately for short term savings, interest rates right now are terrible. For a savings account, you are looking at virtually zero from a brick-and-mortar bank. If you look at an online bank, you can earn closer to 0.75%. When it comes to bank CD’s, you are looking at about 1% for a 1 year CD. For a 5 year CD, you are looking at closer to 2%.
Ideally, you can create a CD ladder with the $100,000 by putting $25,000 in a 6 month CD, $25,000 in a 1 year CD, and $50,000 in a 2 year CD. Then, as they mature, you can reinvest the money into another CD. This will help you to take advantage of interest rates should they rise.
The trick though that you could use is to put $25,000 in a 1 year CD, $25,000 in 2 year CD and $50,000 in a 5 year CD. While you will need the money before 5 years is up, you can always withdrawal the money from the CD early and pay the penalty. Now before you do this, you need to do the math. Figure out what the penalty is for taking your money early from the CD and how much you will earn during that time. Subtract the penalty from the interest and see what you would end up with.
I’ve played around doing this a little bit and have found mostly that doing this isn’t worth it unless the penalty is extremely minor. I’ve used the typical “3 months of interest” penalty and the extra income you earn by investing in a longer term CD is not worth the hassle.
What About Bonds
I would usually tell you to look into some short term bonds to earn some more interest, but I am a little concerned over the short term for bonds. As the Fed starts to wind down their easing and no longer pump money into the economy, bond yields are going to rise, meaning bond prices are going to drop. We started to see this last week when bonds took a beating.
In all, your best option is to just deal with the low interest rates currently being offered by short term savings. Remember, that when it comes to investing, risk and reward are related. So for the “reward” of not losing any principal, you earn a little bit of interest. It’s not ideal in the sense of earning interest but it is in the sense that you don’t want to lose any money. You can also read this post for another point of view on this same topic.
Readers, what you you suggest to Tyler regarding short term savings?