CHAPTER
7

Where to Save Your Money While Planning

In This Chapter

• Keeping your investment or emergency fund safe while you build your account
• The risks and protections of various accounts
• Which savings accounts earn more
• What you trade off with various savings accounts

When interest rates are low, people hate to save money they could be investing—their money isn’t increasing in value. But one thing their money isn’t doing in a simple savings account is good: it isn’t decreasing in value, which is easy to do with a bad investment.

Keeping some money in cash—meaning in a checking account, savings account, or money market account—allows you to have “dry powder,” so when the market offers you an opportunity to bag some big game, you’ll be ready to fire that musket. But where should you stash your war chest? Of course, you also need somewhere to store your emergency fund (at least 3 to 6 months’ worth of emergency cash).

In this chapter, we’ll look at the different ways you can save money for quick access—regardless of what you want to do with it—and examine the pros and cons of each.

Saving in Your Mattress

Keeping cash, precious metals, or gems on hand is not an investment; it’s the ultimate disaster prevention. If the government collapses, or you have to leave the country quickly, or you’re trying to hide your wealth from someone, you might consider keeping a stash—maybe those gold coins—at home. But keeping cash, precious metals, or gems on hand is not without serious risks. Apart from the fact that you won’t be earning interest on your money, it’s subject to other risks. If you’re burglarized, have to evacuate ahead of a hurricane or other disaster, or have a fire, your money can disappear instantly. If it’s a significant amount, and you or your heirs eventually bring it into a bank or investment house—well, you may have some explaining to do.

A bank safety deposit box is a safer choice, but for investments such as jewelry or art that you may actually want to see or use in the meantime, easy access is a problem. (If events occur that make accessing your gold coins necessary, you’re probably not going to be able to get into the bank anyway.)

Please don’t keep stock certificates at home or anywhere else. Most companies no longer issue actual paper certificates; it’s all electronic now. But you may have inherited some of these ornate beauties from long ago. Just know that stock certificates legally belong to the person who has them in their hands, so if you’re burglarized, they’re now somebody else’s unless you’re registered as the owner, have copies of the certificates, or can prove that you owned them.

Many certificates become worthless—the company merges or gets bought out and the certificates must be turned in during a specific period. Unless you monitor this kind of activity very closely, all you’ll have is a very pretty relic. If you have some sentimental attachment to your certificates, make a copy and frame one, and bring the originals into a brokerage, where they will be held in the street name.

Definition

Street name is used when securities are held electronically at a stock brokerage, custodian, or bank.

If you do want to keep some cash on hand for emergencies, keep a small amount where you can grab it in a hurry.

The Necessity of Banks

You’re probably going to need the services of a bank. Banks offer one advantage that no other investment home does: your money is insured up to $250,000. Even if the bank goes bust, the Federal Deposit Insurance Corporation (FDIC) guarantees you will get your money back.

Two types of accounts you will need are checking and savings accounts. You might also want to open a special savings account for money you’re saving to invest.

Checking Accounts

Your checking account is for paying bills. But you can also use it to help with savings by setting up an automatic transfer from checking to savings every month. When that withdrawal happens just like any other bill, you’re more likely to meet your savings goal.

Warning

Don’t keep either your emergency fund (3 months’ worth of expenses) or your investment-building savings in your checking account. It’s just too tempting to tap it to cover spending.

Savings Accounts

In addition to a checking account, banks will offer you a variety of savings accounts. While interest rates are low, the returns on these accounts are usually dismal, but they’re as safe an investment as you can get. Remember the relationship between risk and return? Absolutely safe equals low return.

Definition

Return is the money you make from your investments. It can be interest, dividends, or capital gains (money you make from selling your investment). Some investments offer a return only in the form of interest (think bank accounts) or dividends. Some investments have a combination of dividends or interest plus increase in price, referred to as total return. If a stock pays a 2 percent dividend and goes up 6 percent in price, you have a total return of 8 percent.

Safety is one advantage in saving at a bank. The other is immediate accessibility. You can walk into a bank any day of the week (except maybe Sunday) and access your money. For many banks with online account services, you can instantly transfer money from a savings account to checking on your computer or cell phone, without having to go into the bank physically.

I recommend you consider a bank as a good place for your emergency fund. This is a fund you want to be able to access on very short notice, and from which you could withdraw actual paper money if necessary. (See Chapter 1 for more on emergency funds.)

Banks will generally offer you a plain vanilla savings account with a very low interest rate. If you’re willing to keep a higher, defined balance in the account, you may be offered a slightly better rate. Willing to lock up your money for 3 months, a year, 5 years, or somewhere along that timeline? The longer you guarantee to leave it there, technically purchasing certificates of deposit (CDs), the more interest they will pay you. If, however, you need your money unexpectedly and have to cash in the CD, you will generally lose all your interest and will probably be charged a penalty as well.

Investment-Building Accounts

Consider keeping a separate account for the money you’re squirreling away for investing.

Warning

Banks only insure you up to $250,000 per individual—the sum of all your accounts in that bank. If you inherit money or sell a house—nice problem to have—distribute the money across several banks so no one bank is holding more than $250,000.

Internet Banks

Internet banks are a relatively new phenomenon. Because they have lower operating expenses, they can offer higher interest rates on savings. Not a lot higher (maybe ½ to ¾ percent), but if you just can’t stand to see your funds earning practically nothing, they may be a good option for half of your emergency fund or a place for your soon-to-be invested account. For safety’s sake be sure that the internet bank is insured by the FDIC.

Besides paying a bit more interest, internet banks seem to cultivate a hip image. Some of them offer an option to set up separate “sub accounts” for “estimated taxes,” “vacation,” “investment-building,” or “house down payment.” It’s another way of organizing your saving behavior, and a good one.

Any disadvantages to internet banks? The main one is it can take a little while to get your money—usually about 3 business days. Not all that long if you want to access your investment-building account, but if you need money from your emergency account, not so good.

For example, one lovely Saturday morning a huge tree fell across my sidewalk and front entry and into the street (just missing my neighbor’s house, thank heavens). My emergency fund at the time was at an internet bank and I needed the money in my checking account immediately. If the money had been in my local bank, I could have transferred it to checking, but instead I had to wait several days to see the funds appear. Luckily the arborist who took care of the situation was patient and could wait a few days to be paid.

I no longer use an internet bank for emergency funds but prefer neighborhood banks. I like the idea that they are controlled by and are investing in the local community, and if I ever need a loan, there’s a person to talk to who may have a bit more flexibility in evaluating my worthiness. With an internet bank or one of the big banks, you’re part of a formula, so it’s all much more impersonal.

Tip

Check to see if the banks you’re considering offer automatic transfers from checking to savings. The less you touch your money, the more likely you are to hold on to it. Also, see if you can deposit checks by scanning them on your cell phone—you’ll cut down on your trips to the bank. And read emails about new services with healthy skepticism—they usually mean new fees.

Credit Unions

Something that looks like a bank and quacks like a bank, but isn’t a bank, may be a credit union. These are nonprofit financial institutions that return their profits to their shareholders in the form of slightly higher interest rates on savings. Many people like to use them as a way of being more socially responsible, since they invest in the local community and are owned by local shareholders (you!).

It’s well worth checking them out if you think you might need a loan anytime soon, because they can be a bit more flexible for their members. And that’s the catch—you have to be a member. Credit unions require you to be a member of a group: a specific religious organization, a specific employer, professional association, or even that you live in a specific area.

If you’re interested, look around at the membership requirements of the ones in your area—chances are you’ll find one you can join.

Your deposits (technically, shares) at a credit union are insured by the National Credit Union Insurance Fund up to $250,000 per individual.

You can choose funds that invest broadly in short-term investments, or ones that invest only in U.S. government securities (like short-term treasury bonds), or ones that invest only in tax-free securities. When interest rates are low, the choice between taxable and tax-free may not make much difference, but when interest rates are higher, tax-free securities may give you a better after-tax return if you’re in a high tax bracket.

Definition

A money market fund is a fund that invests in short-term bonds and other debt securities. When you invest in the money market fund, your deposits earn interest based on the market rate of those securities. Each share generally has a constant value of $1. Securities are any financial instrument that gives you ownership in a publicly traded corporation (stocks), show that you are a creditor of government or a corporation (bonds) or have a future right (options).

It’s important to note that money market funds (or any mutual funds or stock investments) are not insured and in the event of a market collapse you may not get your money back. Also, although only two money market funds have (so far) ever “broken the buck”—share value dropped below $1—there’s no guarantee that it can’t happen.

Warning

Beware of offers you get for “private banking.” You’ll pay high brokerage commissions or top-of-market managed account fees. If you decide you do want private banking services, first check out whether your “private banker” is a fiduciary (legally required to act in your best interests), and whether they will construct your model portfolio with any no-load (no-fee) mutual funds from companies other than ones they own.

The Securities Investor Protection Corporation (SIPC) guarantees against the loss of securities should the firm fold. However, it does not guarantee loss of value—your securities can lose value or become worthless, but you will still be guaranteed ownership. Be sure your investment custodian is covered by SIPC. And keep an eye on what’s going on in your account; SIPC does not protect against fraud or identity theft. On the other hand, money market funds are regarded as very safe, based on the type of securities they invest in—short term and usually government based.

Warning

If you invest in a money market fund as a holding pen for future investment funds, keep your eye on the news. There’s interest in passing new laws to prevent instant withdrawals or require higher minimums to prevent “run-on-the-bank” problems caused by people fleeing to the safety of cash in the wake of bad economic news.

You could build up your investment account at a mutual fund or brokerage where you intend to invest in the future. You will be able to make transfers and purchases easily when you’re ready. However, you should check out the minimum deposit necessary; some money market accounts can be opened with as little as $500, but others require $3,000 or more. And if you have other investments with the same company, it may permit you to have a lower balance as time goes on.

If you begin investing in other mutual funds or stocks with the same investment house, the institution will generally open a money market fund for you as a “sweep” or “settlement” account. When you sell an investment, the proceeds will be swept into the money market. When you purchase, funds will be tapped out of the money market.

If you have an investment that pays dividends, or a mutual fund that pays capital gains at some point during the year, you can choose to have those received as cash and deposited in the account, where you can write checks to yourself or your creditors, or hold the money for future investments. If you’re depending on your investments for income (if you’re retired, for example) rather than primarily for building wealth, you can write yourself a “paycheck” from the money market fund.

Tip

If you have an investment that pays dividends, or pays out capital gains (usually at the end of the year), you can choose to have the dividends reinvested in the same investment, buying more shares. Those extra shares will then earn dividends. Over time, you’ll see a better buildup of value than if you took the proceeds in cash, as long as the investment does not decrease in value.

Generally a mutual fund may require that a check be written for a minimum amount (often $250) and that deposits coming from outside also meet a minimum. This does not apply to deposits of dividends, and may also be waived if you’ve set up an auto-deposit directly from a checking account, which you should consider to automatically save your goal amount.

Some brokerage houses may also offer you a debit card or low-cost credit card as a perk for the account. From time to time some offer a cash bonus or even travel or mileage points if you deposit a certain amount and keep it on deposit for a length of time. If this is important to you, you should consider the benefits that are offered, but be careful that the value offered is worth the strictures on your account activity.

Tip

Many mutual fund companies offer free webinars, white papers, literature, and other education to teach you about different kinds of investments. Sure, they’re trying to sell you something, but if you take it with a grain of salt you can learn a lot.

Like banks, brokerage houses can be internet-only or have physical locations. (Most mutual fund companies have only a few or no locations, with the exception of Fidelity.) However, any brokerage with a walk-in office (even the lower-cost ones like Scottrade or Charles Schwab) are doing it as much for their convenience of selling you something as for your convenience. Also, physical locations drive up costs, and guess who ultimately pays those costs? Online-only services will have plenty of people available by phone to walk you through any forms, assist in fixing difficulties, and answer questions.

Ironically, many investment forms will require you to get a signature guarantee, so you’ll probably need to go back to your bank, anyway.

Definition

A signature guarantee is when the bank guarantees your signature. They are corroborating that you are who you claim to be (which usually requires that you have an account at that bank).

Other Places to Store Cash

From time to time I get a client who can’t bear the idea of “all that money” earning, essentially, nothing. If you’re keeping more than 3 months’ worth of expenses, and you’re willing to take some risk, you might consider short-term bond mutual funds or stable value funds.

Short-Term Bond Mutual Funds

This type of fund invests in bonds with a term of 3 months or less, which means they pay pretty close to what a money market fund pays. However, they do yield slightly more. For example, if an internet bank is paying 1 percent interest on savings, a short-term bond fund might yield 1.35 percent.

Definition

Yield is the interest or dividends paid on a security.

Sounds good, right? Well, we need to remember the concept of total return. Unlike a money market fund, a mutual fund doesn’t maintain a constant share price. So let’s say you invested your money in a short-term bond fund at a per share price of $10, expecting to get dividends of 13.5¢ per year. But the market share price drops to $9 per share. So you’ve lost 10 percent and your total return would now be a loss of 8.65 percent. That yield isn’t looking quite as good, right?

In any bond investment, the bond price tends to move the opposite way from the yield (see Chapter 12 for a more in-depth discussion). So if the share price is high, the yield will be low. If the share price drops, the yield will go up. This is why bonds tend to maintain overall steadiness, or at least don’t vary as much as stocks—price and yield tend to balance each other to keep total return fairly steady. However, depending on when you invest and what the market does after you invest, your return can vary.

In real time, short-term bond funds tend to vary less—if the median price of a share is $10, you’re more likely to see it range up or down 20¢. If you plan on leaving it parked for a long but undefined period of time, eventually the dividends paid will build up and smooth over the price variation. But you’re taking some small risk for that slightly smaller possible reward.

Short-term bond funds do not have check-writing available. You must sell shares to get your money. The sale needs to settle, which means your money won’t be available for about 3 to 5 business days. Then, you will need to transfer the money to your bank, or write a check from your money market account. It can take much more time to access your money from a short-term bond fund than other types of emergency funds.

Stable Value Funds

The other option for investing cash is generally only available in some workplace retirement funds: the so-called stable value fund. These are mutual funds with a guaranteed (by the fund company, not any government agency) minimum (low) level interest rate ranging from about 2 percent to around 3.5 percent. People have piled into them because stable sounds good, right?

However, as with all low-return investments, you’re missing out on the possibility of higher return. If you’re very near retirement, this can be a place to put your first 2 to 5 years of retirement cash needs (so you can withdraw it with some certainty of how much is there), but because they are currently only available in retirement accounts (and some college savings accounts), they’re probably not a viable investment for most cash-need purposes. If you’re far from retirement, you should select a better investment to receive your contributions.

Managing your cash, whether for emergencies or to build up money for investing, has a goal of being available on short notice. It’s money you can’t afford to risk because you need the full amount to be stable, so you give up the possibility of much growth through return to have it available as needed. Sure, you prefer higher earnings—we all do—but your cash is your insurance policy to protect your lifestyle and your ability to make investments once this foundation is in place.

The Least You Need to Know

• There is no perfect or absolutely safe investment—any place you put your money carries some risk.
• Banks and credit unions offer insurance for your principal.
• Internet banks may offer you a slightly higher rate on savings, but accessing your money takes longer.
• Money invested with a brokerage or insurance company should have insurance against fraud, but you aren’t protected from market loss.
• Even if your principal is safe in a money market fund, you can lose money to low-return investments because of inflation.