Amy Buttell Crane, Writer & Editor

Mutual Fund Matters, September 2005

Maximizing Savings Interest

By Amy Buttell Crane

A Federal Reserve Board committed to raising interest rates is a dream come true for investors bent on making more on their savings. But since the markets aren’t playing along, investors are in a bit of a pickle: how long to commit their savings to get the best rates without being left behind when and if rates do increase.

And savings isn’t just a matter of harvesting the best rates. First you have to figure out what you’re saving for and make a plan to reach that goal. “The best advice I can give about saving is to stop procrastinating and figure out an achievable plan,” says Arnold Presser, senior portfolio manager for Citizens Bank – Wisconsin. “Even taking a baby step of $25 or $50 a month is a start.” Once you’ve taken those actions, it’s a bit easier to figure out where to put those savings.

Conventional wisdom dictates that you shouldn’t invest any money you’ll need in the next five years in the stock market. For once, the conventional wisdom actually does make sense – you don’t want your stock investments to meltdown just when you need a lump sum to make a down payment on a house or pay college tuition.

So where to turn? From simple savings accounts to short-term bond funds, the variety of options for savings is bewildering. When it comes to actually investing your savings, your comfort zone has a lot to do with which investments will work for you. For some investors, federally insured accounts provide the security they need, while other investors would rather take some risks, even with their savings, in order to get a higher return.

Your Savings Goals

Most investors have multiple savings goals. Parents with young children may be simultaneously saving for a house, for their children’s college education and their own retirement. Retirees need to maximize their interest gained on savings to maintain their standard of living – this can include paying for day-to-day expenses such as food and medication or for extras such as vacations.

And virtually everyone, regardless of his or her situation in life, should have an emergency fund. The money in this account should be liquid – that is, easy to access – and could run anywhere between three to six months of your and your spouses’ salary. Once you start an emergency fund, be strict with yourself about how you spend it.

“An emergency fund is for true emergencies,” says Presser. “These would be things like unexpected medical expenses, to pay loans if you lose your job or big car repairs. Don’t use your emergency fund to buy a new car or go on a vacation.”

While emergency fund monies should be in a liquid account such as a savings or money market account, you can be more creative with other savings that you don’t think you’ll need for a while. For example, if you plan to buy a new car in three years, you could go with a short-term certificate of deposit (CD) or even an ultra-term bond fund to juice your returns a bit.

Rob Shenk, vice president of E*Trade Bank, says, “A lot of financial institutions make a lot of money off the inertia of their customers, who have cash holdings but aren’t aware of the options to maximize the interest from those holdings.” Even with savings accounts and money market accounts, there are many options available, many with higher interest rates than you may be getting currently and it pays to investigate those options.

The Options

There are numerous options for your savings dollars. Here’s a summary, and the table on page ? gives some pros and cons to each type of account.

Savings Accounts are available at banks, credit unions and savings and loans and offer nominal interest. While this isn’t the best place to stash a large amount of savings, it maybe a good place to get started if you’re just beginning to build an emergency fund or have less than $1,000.

Certificates of Deposit come in different maturities and are offered by banks and brokerages. Most investors are familiar with plain vanilla CDs that offer a specific return; however there are variations available. See the Understanding CDs FAQ at http://www.bankrate.com/brm/news/sav/20020805a.asp .

Money Market Deposit Accounts are offered by banks, savings and loans and credit unions and are insured up to federal depository insurance limits of $100,000.

Money Market Mutual Fund Accounts are offered by mutual fund and brokerage companies and are not insured. However, they pay higher interest and so far no fund company or brokerage has defaulted on these accounts (known as “breaking the buck”).

Short-Term Treasuries range from savings bonds to treasury inflation-protected securities (TIPS) to federal bills and notes maturing anywhere from three months to five years. All treasuries are backed by the full faith and credit of the U.S. Government.

Short-Term Bond Funds come in a number of different varieties: ultra-short term and short-term. Ultra-short term funds purchase bonds with very short maturities, usually less than two years, while short-term bond funds usually go for bonds maturing within one to three years. You can find both types of bond funds that invest in tax-free or taxable bonds as well as corporate and high-yield, or junk, bonds.

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