Reader Writes: Short Term Savings

Short Term SavingsI received an interesting email from reader Tyler this past week that I thought would be great to share with everyone that concerns short term savings.

“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.

Final Thoughts

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?

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  1. says

    Good suggestion Jon. I like the CD laddering idea, especially if they’re looking to preserve the capital. I know the rates suck, but it is what it is and would avoid the advisor friend as that is a hefty fee. It’s a shame that they’re not ready to buy a house now as who knows what rates will do in the next few years…they can really only go up.
    John S @ Frugal Rules recently posted..Do We Care About Our Employers Anymore?My Profile

  2. says

    Tyler said that he wants to use some of the money to purchase a house. He might begin to plan on how much that might be and set that amount aside in CDs like you suggest. The remainder he should feel free to invest in the markets. Investing is a very important part of growing long term wealth. And I agree…do the investing yourself. It’s not that difficult to figure out how to put money into some low cost mutual fund at Vanguard.
    Brian @ Luke1428 recently posted..Funding College: Should I Work or Do SAT Prep?My Profile

  3. says

    Nearing retirement and with two in college, I’m pretty risk averse. My advice would be to park most of it in short term CDs to see what the market is going to do. I’ve heard too much speculation about a correction to advise anyone to buy high. Give it a little bit of time. If you want to keep your friend, don’t allow him to invest your money for you.
    Betsy / CollegeMom recently posted..How to save on groceriesMy Profile

  4. Nick @ says

    A lot of this depends on the age of the reader. I would suggest putting the portion of the money for a house down payment in a CD ladder as well. Then I would invest the rest in low cost mutual funds with an aggressive mix. 1.4% for fees is way too high in this day and age!
    Nick @ recently posted..Blog Roundup #16My Profile

    • moneysma says

      Ah, Uncle Sam. Great point Michael. Depending on where the money did come from, he might want to stash a little of it away for the tax man.

    • moneysma says

      Good point. Tyler needs to come up with an idea of how much he will need for the house, put that aside in a safe, short-term investment and then he can invest the rest in the market, with a longer time horizon.

  5. says

    Don’t pay the friend, that doesn’t seem like a good solution. With the market having experienced such a run up in recent years, it remains to be seen what might happen in the next few years. With an interest in spending on a home, it seems like that money might have a short-term horizon. If that’s truly the case, keeping it safe in low-risk investments might be the way to go.
    Tie the Money Knot recently posted..Father’s Day Financial LessonsMy Profile

  6. says

    Vanguard has some great cheap fees with their at cost investment options. In fact a lot of their fees run around 0.23% and higher which is incredibly cheap. Laddering CD’s is another good idea, but another option is to consider places like Lending Club, you could invest in some really secure loans and possible still get around 4 to 6% returns and their isn’t any BS fees involved with them either.
    Chris @ Stumble Forward recently posted..5 Reasons Why We Make Terrible Financial DecisionsMy Profile

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