Savings, CDs, Money Markets and Linked CDs

Many people ask me about savings accounts, money markets and CDs, and the latest version of CDs, market linked or index CDs:

Q. Most financial experts say that we should accumulate 3 – 6 months of income or expenses in a safe savings account, for emergencies, such as job loss, uninsured damage to property or health care, for example. What kind of savings account or investment account should that be put into? A. The type of account should be 1. easy to get to, in a moments notice that provides check writing capability, or the ability to move funds electronically very quickly, without waiting for a delay for investments to be sold. 2. It should be FDIC (bank) or NCUSIF (credit union) insured, so that if the financial institution becomes insolvent, your money is guaranteed to be there. 3. The type of account should have no early withdrawal penalty, also know as a CDSC or contingent deferred sales charge unless very small. 4. The account should not be set up as a tax qualified account (e.g., IRA) because they usually have taxes and tax penalties to get your money.

Q. What types of accounts meet all of these 4 qualifications? A. A bank or credit union savings account, sometimes referred to as a passbook savings account qualifies. The second most common account is a money market account, or also known as a money market mutual fund. However not all money market accounts are FDIC insured, so make sure you find out. Short term CDs or certificates of deposit may also qualify, but they may have an interest penalty if you withdraw the money before maturity.

Q. Which account pays the highest rate of return?A.  Typically insured accounts are paying interest in the .50% – 2%, the same goes for CDs. For CDs usually the longer term and larger amount you have to deposit correspondingly pays a little higher interest rate. For all of these accounts most rates are much less than 2%, and their isn’t a great difference between accounts. Savers should check with several financial institutions to find the best rate for these accounts. Some banks and credit unions in our area offer interest rates closer to 2%, and you might find one where you live too.

Q. Why are the rates so low, and are they any ways to get a better rate of return yet still maintain the requirements of safety, access, and no penalty, for example I have heard of Linked CDs? A. The accounts discussed so far are all safe accounts that earn a low rate of return for a few reasons, one being that the institution where you are making a deposit is legally required to invest your money in very safe investments such as highly rated government securities that don’t pay much interest, and the institution is required to pay a higher premium then they used to have to pay for the insurance protection. Since financial institutions like banks and credit unions are paying such a low rate on savings, CDs and money markets they have come up with some creative ideas to provide the possibility of higher rates of return yet maintain safety.  These hybrid CDs provide rates of return based on an underlying stock, bond or commodity index, or basket of them, and a percentage of the performance to the CD holder. The upside performance at maturity is limited to a specific percentage, and the downside is limited to 0% at maturity. These go by a number of names such as index or variable rate CDs to mention a few. They may have surrender charges too, which might make them not a fit for an emergency savings account, unless the saver has a lot of liquid assets. Before investing, obtain full materials and thoroughly read it and ask many questions of your investment advisor, as well as obtaining information about prior performance if available, even though past performance is not an indication of future results. As with all decisions, seek the advise of trusted advisors, and pray before you choose which way to go.