In a world where inflation is eating away at the value of your savings, it's crucial to strategize how you store your cash. While inflation is a normal part of the economy, the current rate exceeds the Federal Reserve's goal of 2% annually, meaning your money is losing purchasing power. So, where should you park your savings? Let's explore some options and consider the pros and cons of each. Personally, I think the key is to match the cash vehicle to the time horizon for when the money is needed. For money you may need in the coming months or within the next few years, you shouldn't try to take on too much risk. What makes this particularly fascinating is that while cash provides liquidity, the difference between what a major bank pays on a standard savings account and what you can earn at an online bank or credit union is real money, and most people are leaving it on the table. In my opinion, the best strategy is to keep emergency savings accessible and to match the cash vehicle to the time horizon. For money set aside as a cushion or emergency savings, many advisors recommend high-yield savings accounts. What many people don't realize is that the current national average savings account annual yield is 0.62%, compared with some high-yield savings accounts paying around 4%. This means that if you're not taking advantage of these higher yields, you're essentially losing money. One thing that immediately stands out is that money market accounts offer a place to park your cash and earn interest, similar to a high-yield savings account. Plus, they often come with check-writing ability or debit card access. However, they may require a higher minimum balance than savings accounts. If you don't need immediate access to your cash, you can also consider certificates of deposit (CDs). CDs have a set term that can range from a few months to five or more years. At maturity, your bank returns your principal plus the interest it guarantees. However, this makes CDs less liquid - if you cash out early, you'll typically pay a penalty representing a portion of the interest. What this really suggests is that while CDs can offer higher yields, they come with a trade-off in terms of liquidity. For cash you can hold for six to 12 months without touching, short-term treasury bills are worth a serious look. Treasury bonds and bills are also a relatively safe place to put cash, but they vary in liquidity and interest payments. Right now, a three-month Treasury has about an annualized 3.7% yield; for a six-month Treasury, it's 3.8% and a one-year bill is about 3.9%. What makes this especially interesting is that Treasury ETFs may be an option. It's also possible to get exposure to Treasury bills through exchange-traded funds, which trade throughout the day like stocks and may be either actively managed by professional investment managers or passively managed, meaning they track an index. However, there's a cost to owning ETFs. The average annual expense ratio for bond ETFs that own Treasurys is 0.17% for actively managed ETFs and 0.09% for those that are passively managed. This raises a deeper question: are the benefits of ETFs worth the cost? For higher-income investors, tax-free municipal bonds can be worth considering because the after-tax yield may be more appealing than the stated yield suggests. However, be aware that despite the typical tax-exempt status for the interest earned, the formulas for Social Security taxes and Medicare premiums use your so-called modified adjusted gross income, or MAGI, which includes tax-exempt muni bond interest. Lastly, I bonds come with decent yield but less liquidity. The U.S. Treasury Department also issues savings bonds through Treasury Direct. For example, Series I bonds that are purchased May 1 through Oct. 31 of this year will pay 4.26%. However, when you purchase I bonds, you can't access the money for at least one year, and if you cash out before five years, you lose three months of interest. In conclusion, while inflation is a normal part of the economy, it's crucial to strategize how you store your cash. By matching the cash vehicle to the time horizon and taking advantage of higher yields, you can combat the effects of inflation and protect your savings.
