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There are many questions here about where to invest short-term money where the goal is to preserve principal and maximize risk-free return. This money is usually a large sum that is needed within 0-2 years to make a big purchase such as a home, property, vehicles, etc. Rather than try to make similar responses to each post, I thought I'd make a single post with the most popular options and start pointing these questions to this post.
This is certainly not a definitive list of options, but it gives an overview of the current popular options and current typical rates, pros, and cons of each. I will update occasionally as necessary. Please feel free to make recommendations to changes I should make.
Savings accounts are offered with competitive rates by several different banks. Yields are currently around 2.20% for an account that doesn't require much work.
Money is liquid.
Only $250k per account is FDIC insured.
Taxed at the Federal and State levels.
Money Market Funds are funds that generally invest in short-term government and commercial securities and are available through your preferred broker. Both taxable and non-taxable funds are available. Funds are currently returning around 2.35% to 2.5% for taxable and have a similar equivalent yield in non-taxable (but can be better if you're in a higher tax bracket)*. Funds are also available that are state and tax free if you live in certain states.
Good liquidity - can usually have your money the next day.
Not insured, but generally considered low risk due to primarily being invested in short-term government and commercial securities.
Some funds have high minimum investments.
Treasury bills are available for purchase directly from the US government through Treasury Direct or through your broker**. They are offered a in 4, 8, 13, 26, and 52 week bills with slightly increasing yields, and yields are currently starting at a little over 2.4% and going to about 2.55%. Treasury notes with a 2 year maturity are also available.
Backed by the US government.
Income is not taxed at the state and local levels.
Minimum investment is $100 through treasury direct.
No real maximum limit.
Can lose value if you don't hold the bill to maturity. More information can be found here.
If purchased through Treasury Direct it's more difficult to sell you bills if needed.
Brokers generally require purchase/sales in increments of $1000 with maximum limits as well.
Certificates of Deposit (CD's) are available through many outlets: banks, brokers, insurance companies, etc. Returns are up to ~2.75% for 12 months CD's.
Taxed at Federal and State levels.
Can lose value if withdrawn early (varies by company and type of CD) - Read the fine print.
High-Yield Savings and Checking Accounts may return 3.5% or more.
Better yields than a normal savings or checking account.
Generally many monthly hoops to jump through. Often requiring a direct deposit, certain number of transactions, minimum balance, maximum balance, or some combination thereof to be eligible for the advertised rate.
Can return 0% if all of the requirements aren't met. - Read the fine print.
Many of these rates are introductory and get smaller with time.
Now that I've tried to give unbiased information, I will say that I personally*** don't like option #4 and #5. There's just too much overhead and work and not enough additional return to compensate. I err on the side of keeping it simple. The first two options are very simple. Option #3 is not as simple, but can offer a bit higher return without too much risk or work. I also personally think that if you are interested in option #3 that you should start by purchasing a $100 4-week bill through Treasury Direct just so you can see how the whole process works before investing further money.
** - It is highly advised to speak with a representative at your brokerage of choice before buying or selling treasuries on the secondary market. It is important to understand all of the nuances (fees, bid-ask-spread, yield-to-maturity, potential losses, trade schedule, etc) of investing in this manner before purchasing. While not particularly complicated, there is more to it than simply buying and holding at Treasury Direct.
*** - I am not your financial adviser. You make elections on which investment vehicle you will choose on your own behalf. I am simply providing information so that you can make a more informed decision on what vehicle works best for you.
[edit] updated typical rates.
regarding T bills, there are 26 week bills not 24, and I believe an 8 week bill is coming soon. These are not likely to "lose" value even if not held to maturity, but when you sell you won't get the full face value. For simplicity you might buy a $1000 T bill for $990, and if sold early maybe you only get $995, instead of the $1000 if held to maturity. Make sense? Also, at brokerages you can usually only buy in $1000 increments. I would also add the "purchase" factor is a little more involved. You can't just go buy one any day. They're auctioned and issued on certain days. You can enter purchase orders ahead of time, but at a brokerage, only after the auction is announced. So at a brokerage the 4 week auction may be announced Monday and happen Tuesday. You only have one day to actually enter the order. Scheduling purchases and reinvesting is much easier at Treasury Direct.
regarding high yield savings and checking I would argue "can often return 3% or more" is not true. I would change "can often" to "may*"
Great feedback! Thanks jacoavluha!
I will make some corrections and gather a bit more information. I have not bought t-bills through a brokerage, only through TD. So I'll admit that my experience with buying/selling bonds through brokers is extremely limited. I did realize that auctions only happen periodically, but I didn't realize the trading of bills through brokerage was also limited to those action days. Do I have that right? Can you provide me more information on this, perhaps some literature?
A t-bill is essentially a short-term bond. Bond values go down with lack of demand. I assumed (perhaps incorrectly since I've never sold a bill) that if you bought a bill for $980 you could end up selling the bond for less than $980 if that's the going rate. The "going rate" is tied to the current interest rate. Example: Imagine I purchase a $10k 52-week bill with a 3% coupon rate. At the next auction (4-weeks later) 52-week bills are selling at a 4% coupon rate, resulting in a lack of demand in my bill. To remain competitive I would have to sell my bill at a reduced price. I will lose equity if I sell because the new bills are worth more. I'd have to calculate the exact amount to figure out how much, but I'm short on time, and I've hopefully framed the scenario adequately.
Thanks COEE, great info as always. I'll refer to this myself when needed; it'll be useful to just post it to new threads that ask the same thing over and over again. Maybe we could even make this a sticky thread?
This is something that I consider every year and I have been to fearful to pull the trigger. I share an online bank account with my high school aged child through an account called Simple. It is a part of BBVA Compass. Recently I was made aware that they offer a 2.02% APY savings account with a $2k balance or more. It seems pretty straight forward and, thanks to your breakdown above, I think I am going to try it. Does anyone have any experience with Simple?
If there's any disagreement on the ranking we can discuss them, but I think making the options as easy to compare as possible is important.
I think one thing also worth mentioning is the definition of "need" one uses in making these decisions. While the options you've laid out are absolutely where money that is NEEDED should go, it can be appropriate to invest money that is "needed" in the stock market assuming the "need" is actually a WANT. That is to say, often these questions come in the form of "I'd plan to buy a house in the next two years if I find something I like. What should I do with the downpayment?" The question one should ask themselves in a situation like this is whether loss of some of the money is acceptable? Are you going to buy the house no matter what the broader economy is doing? Or are you likely to actually prefer buying during a depressed economy? Then sticking the money somewhere safe is your best bet. Are you willing to take the chance that the money isn't there when you want it, and if that's the case you'll be flexible and put off the purchase? In that case investing the money could be a viable (or even preferable) option.
There's a difference between buying new issue treasuries (purchased at auction) and buying/selling on the secondary market. Buying new issues is limited to auction days. You can buy and sell on the secondary market whenever. But it's not as straightforward as buying and selling equities. Further discussion of this is not necessary here. For people considering short term savings