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With inflation increasing and the Federal Reserve raising interest rates, you would think that your savings account would start paying you higher interest.
What can you do to take control of your money and start getting higher interest rates?
Two little options that many people overlook are I Bonds and Treasury Bills.
Why should you consider these?
Right now, they are both earning over 4% interest and, in the case of I Bonds, closer to 10%.
Keep reading for a full breakdown between I Bonds vs. Treasury Bills and see how they compare to high-yield savings accounts.
Table of Contents
How To Get The Highest Return On Your Short-Term Savings
What Is An I Bond?
An I bond, or US Series I Savings Bond is similar to the savings bonds your parents and grandparents gave you on your birthday when you were young.
They are interest-paying investments that are bonds from the US Government.
Since this is a bond, you don’t risk losing money on this investment.
The money you invest is the money you get back, plus the interest you earn.
The interest, though, is linked to inflation, which is helpful in general, but currently, in 2022, the rates are incredibly high compared to other alternatives because of inflation.
They are purchased online through TreasuryDirect.gov and have rules you should learn about before buying.
What Are The I Bond Rules?
Here are the basic rules for getting started with I Bonds.
- You must hold them for 12 months before cashing them out. This means you must ensure you only put money in that you don’t need for the d8ecf7following year.
- If you cash them in before holding them for five years, you’ll lose the prior three months of interest. This shouldn’t discourage you from buying I bonds, but you should keep this in mind.
- You can only buy $10,000 in online I Bonds per person, or entity, per calendar year. To purchase more, you can have your children, but I Bonds, even your living trust if you have one.
- I Bonds stop earning interest after 30 years, but you could cash them out any time after 12 months. Once you meet the one-year holding period, you can cash them out anytime
What Is The I Bond Interest Rate?
The current I Bond interest rate is 9.62%.
When you buy an I Bond, you are committed to holding it for at least 12 months, yet you usually only know what interest you would get over the next six months.
Twice per year, in May and November, the government releases the new I Bond interest rate, a combination of a fixed rate and variable rate.
Right now, that fixed interest rate is 0.0%, which you get for the life of the bond.
On top of that fixed interest rate, you get an inflation rate that changes every six months on the 6-month anniversary of buying the bond.
For example, if you buy a bond in January, your inflation rate will change every July and January.
Even though the inflation rate announcement was two months earlier, your bond’s inflation rate only changes once it hits its 6-month anniversary.
Many people mistake waiting until the last minute to buy I Bonds before the rate changes.
For example, you can’t buy I Bonds on October 31, thinking you will get the current rate.
I Bond purchases take place the next business day, so if you buy on October 31, your purchase date will be November 1.
Pay attention to when the days of the month fall to ensure you buy before a rate change.
When Should I Buy An I Bond?
You should consider buying an I Bond if you have the money you don’t intend to use for 12 months.
You might be someone who would typically have a CD ladder or 12-month to 24-month CDs for some of your short-term money, but with historically low CD rates persisting, you’d get a higher interest rate through the I Bond.
Here is more information on I Bonds, including an I Bonds Rate Prediction.
What Is A Treasury Bill?
A Treasury Bill is a short-term bond issued by the US Government that matures in less than one year.
Since they are from the US Government, you can count on getting repaid, as you cannot lose money investing in a Treasury Bill.
In 2022 the rates on Treasury Bills are much higher than similar duration bank products.
The average one-year CD is barely 0.6%, yet a 1-year Treasury Bill is approaching 4%!
You can buy them online through TreasuryDirect.gov or a bank or broker.
The advantage of buying through Treasury Direct is that you won’t pay a commission to a bank or broker.
The disadvantage of buying through Treasury Direct is that you would only be able to buy in 4-week, 8-week, 13-week, 26-week, and 52-week increments.
And while you could ask to buy a Treasury Bill anytime, it would only be effective once a Treasury auction occurs, generally within the next 1-2 weeks.
The advantage of buying Treasury Bills through a bank, credit union, broker, or other financial institution is that you could buy existing Treasury Bills that have a maturity date when you’d like.
Do you want a Treasury Bill that matures in 4 months or nine months?
You couldn’t get that through Treasury Direct, but you could get that through the bank or broker.
The disadvantage of buying Treasury Bills through the bank or broker is that you would pay them a commission.
Because of this commission, you would likely see your effective interest rate about 0.05% – 0.10% lower through the broker purchase.
But the advantage of getting the convenience of being able to buy different maturity dates outweighs this for some people.
Why Would You Buy A Treasury Bill?
Treasury Bills are short-term interest rates paying much higher than similar bank products.
Think of it like creating your money market fund for yourself.
You could build out a short-term Treasury Bill ladder with maturity dates that are less than one year and get between 2.5% – 4% on those Treasury interest rates right now.
If you hold the bill until its maturity date, you would know exactly how much interest you could get.
If you needed the money early, you could always sell your Treasury Bill through your brokerage account, although you would pay a commission.
If interest rates go up, your Treasury Bill could lose value.
Because of the short time frame, the loss of principal from interest rate movements usually isn’t much.
High Yield Savings Accounts
What Are High Yield Savings Accounts?
Suppose you don’t like the idea of locking up your money in a 52-week Treasury or being subject to an early-withdrawal penalty like an I Bond.
In that case, the next best option is a high-yield savings account.
Online banks typically offer a high-yield savings account, allowing them to spend more money by paying a higher interest rate.
It is the same as a traditional savings account.
The only difference is it pays higher interest rates.
Online banks can’t compete based on being convenient and local to you.
Hence, they need to focus on offering a higher interest rate and a better online experience than your local bank.
Online banks have the same FDIC insurance as your local bank, so you can be assured that your money is safe with them.
Why Put Your Money In Higher Yield Savings Accounts?
A high-yield savings account is a great way to set aside the money you don’t need for your day-to-day purchases to get a great short-term interest rate.
By linking your online savings account to your local bank checking account, you can add to and withdraw money anytime you want.
Understand that the electronic transfer can take two days to get the money into your checking account.
How often can you think you need a large sum immediately within a few hours on the same day?
It probably hasn’t ever happened to you.
And if you do need money the same day, you could always set up a wire transfer that gets the money into your checking account the same day, usually for a small fee.
Finally, as with the other options listed, you don’t risk losing money with savings accounts.
Your principal is safe, and the only way you lose money is through purchasing power, which I go into more detail below.
I Bonds vs. Treasury Bills vs. Savings Accounts
Since each person is different and has different goals, no one can say for sure you should put your short-term savings.
You have to decide what makes the most sense for you.
For example, if you don’t have an immediate need for your money and want the highest interest rate, I Bonds could be your best option.
On the other hand, building a Treasuries ladder could make the most sense if you are retired or want a recurring income stream.
Or maybe you are saving for a down payment on a house you plan to buy in five years.
In this case, either I Bonds or Treasury Bills would make sense.
Finally, if you want to avoid opening a new investment account and are comfortable with a lower return, a high-yield savings account could work for you.
Of course, you could use a combination of the above as well.
I currently have my money in a high-yield savings account and, at the same time, am buying I Bonds.
With rates on Treasuries climbing, I am considering shifting some of the money in my savings account into this option.
One final note here about opening an account with TreasuryDirect.
The process is relatively simple, but you must take time and triple-check your information before submitting it.
There are horror stories of people entering incorrect information and having an impossible time trying to get through to customer service.
I know someone who missed one digit when entering their bank account number.
It has been two months of trying to talk to someone to get it fixed.
This isn’t to scare you from opening an account.
Just letting you know that you need to take your time.
Should You Invest For Short-Term Interest Or Long-Term Growth?
Now that you’ve learned about the different short-term savings options, a good question is, ‘should I invest this money in short-term interest accounts, or should I be investing for the long run?’
After you’ve set up an emergency fund and have some short-term savings in case you lose your job, you should consider investing money for the long-term.
Typically, short-term interest rates do not keep up with inflation, and any money you plan to use far off in the future is unlikely to keep up.
The technical term is ‘purchasing power.’
Purchasing power is your ability to take a certain amount of money today and turn it into a specific item.
If you can take that money and buy more of that item in the future, you gain purchasing power.
You lose purchasing power if you can’t buy as much of that item.
Suppose your $5 today could buy you a gallon of milk, but instead, you invest that money and earn less than the inflation rate.
In that case, you won’t be able to buy that gallon of milk with that money in the future.
You may have increased your money from $5 to $6, but that gallon of milk might cost you $7 in the future.
That is what economists mean by keeping up with inflation so that you don’t lose your ‘purchasing power.’
Historically, investing in longer-term investments like the stock market is a better way to keep up with inflation and maintain purchasing power.
When you invest through the stock market, you will likely see your money go up and down over time, which feels different from the slow, steady growth of interest rate accounts.
These seemingly wild swings may cause you to second guess your decision to invest in the long run.
This is why using a financial advisor, or an automated trading platform is recommended to try to take the emotions out of your investing decisions.
- Read now: Learn how to avoid emotional investing
At the end of the day, your investment portfolio should have some money in the stock market for longer-term goals, like retirement, and invest in interest-bearing accounts for shorter-term goals.
Frequently Asked Questions
There are a lot of questions about short-term savings.
Here are the most common ones.
Is a money market account a good option?
Money market accounts are very similar to traditional savings accounts, although they allow you to write checks.
However, many money market accounts have minimum balance requirements to open an account in the first place.
As for interest rates, the interest paid on money market funds is usually on the lower side, comparable to a traditional savings account.
Should I invest in short-term bond funds?
Short-term bond funds can play a role in having a diversified portfolio but are not ideal for short-term savings.
The reason is that you can lose money as the bond fund buys and sells individual bonds.
This is true for both mutual funds and exchange-traded funds.
Buying individual bonds is better if you want to invest in short-term bonds.
This limits the risk of losing money.
What taxes do I pay on my short-term savings?
When it comes to online savings accounts, the interest you earn is taxed as ordinary income at the Federal and state levels, assuming you live in a state with a state income tax.
With Treasury Bills and I Bonds, there are tax benefits.
In both cases, you do pay Federal income tax, but they are exempt from state income taxes and local taxes.
The other tax benefit is you can defer the tax you owe until you sell the investment.
Why should I not invest in corporate bonds?
Corporate bonds are a good investment, just not for short-term savings.
The reason is that most of these bonds have a maturity of up to 30 years.
If you invest in these long-term investments and need the money before the bond matures, you will have to sell.
In some cases, you will have to sell for less than the face value of the bond, which ends up costing you money.
While you can invest in short-term corporate bonds, there is a risk of the company going out of business, in which case you risk losing your principal.
You’ve worked hard for your money.
When looking for the best short-term savings options, make sure to take the time and effort to move your money to the best solution for you, whether it is I Bonds, Treasury Bills, or a savings account.
And when you have your debt under control and enough money set aside for emergency funds, take the opportunity to invest for the long run through a financial advisor or automatic investment manager.
That way, you can focus on living your best life and not worrying about short-term changes in the stock market.
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I have over 15 years experience in the financial services industry and 20 years investing in the stock market. I have both my undergrad and graduate degrees in Finance, and am FINRA Series 65 licensed and have a Certificate in Financial Planning.
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