Do you have a large but short-term savings goal? Perhaps, like me, you want to save at least 20% of a future home as a down payment. Maybe you want to purchase another vehicle or recreational toy in cash versus going into debt, or finally finish a much-needed home improvement project. One thing these diverse savings goals have in common is that they’re short-term – you’ll want to be able to use the money in say, one to four years.
If you don’t know how much you’ll need to set aside every month to reach your goal or what interest rate you might need to reach it in a certain time frame, use an online amortization table to help you calculate that number. Knowing what you need before looking at your options will allow you to quickly locate the one that best meets your needs.
So what are your options? You could just deposit cash into a savings account at your bank, but with some of the lowest interest rates around, brick-and-mortar accounts aren’t going to yield much more than you put into them. On the other end of the spectrum, you don’t necessarily want to invest in risky stocks or long-term bonds either.
For short-term savings goals, there are three main features you’ll want to keep in mind:
- Security (possibly FDIC-insured)
- Minimal risk (not subject to market volatility)
- Liquidity (easy, fast withdrawal without penalties)
For short-term savings, it’s more about the return of the money versus return on the money. But while you’re at it, there are several options that can accomplish both with minimal risk:
- High-yield Savings Accounts
- Money Market Accounts
- Investment Accounts
High-Yield Savings Accounts
Interchangeably called online savings accounts since that’s their mode of operation, high-yield savings accounts are becoming one of the most popular short-term, risk-free, highly-liquid options. With lower overhead, online banks can offer higher interest rates – anywhere from 10 to 20 times that of regular savings accounts. Like normal bank accounts, they’re still insured by the FDIC. A few of the downsides to these accounts are withdrawal restrictions (6 or less a month) and the lead time required before withdrawal (up to 5 days). Even though they offer higher interest than regular savings accounts, their rates are still lower than some other options.
Money Market Accounts
Money market accounts, another type of insured account offered by banks, blend features from checking, savings and low-risk investment accounts. Like checking accounts, they often include debit cards, allow you to write a certain number checks a month, and have fewer withdrawal restrictions than online savings accounts. At the same time, they can offer better interests because they trade in short-term, low-risk investments like U.S. bonds and CDs. Their focus is getting the best market return for your money in the shortest amount of time. On the down side, they often require a minimum initial deposit anywhere from $5000 to $25,000.
CDs (Certificate of Deposits)
If you can let your money sit for a while (from 3 months to a few years), CDs can offer higher interest than brick-and-mortar savings and sometimes even online savings accounts. Like other types of bank accounts, they’re also insured. To maximize your earnings without suffering early withdrawal penalties, some recommend splitting up your deposits into 3 or more ‘ladders’ of 3-month increments. That way, if interest rates rise, you can re-invest an expiring CD into a new one with a better rate.
Finally, there are brokerage accounts that let you invest in securities such as stocks, bonds and mutual funds. These are not FDIC-insured, will require brokerage fees, and your investment is subject to market fluctuation. However, if you can afford to take on risk of loss, your investment might earn a higher return. And don’t confuse the money market funds you can invest in via the brokerage firms with the money market accounts we mentioned earlier. Money market funds are mutual funds with low risk offering a minuscule yield nowadays, as oppose to an account type.
As you consider how to save for a short-term goal, consider which of these secure, low-risk, highly liquid, but still interest-bearing options might provide the best return on your money. Who knows – maybe you’ll save and earn enough to exceed your initial savings goal and start working on the next.
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