When investing your hard-earned money, there is often a trade-off between returns and volatility. Low-volatility assets — such as bonds and money market funds — provide modest returns compared to investments such as stocks or cryptocurrencies, which can experience large price fluctuations.
However, both types of investments have a place in a diversified portfolio. Since the Fed has raised its benchmark interest rate significantly in the past year and a half, cash equivalents like Certificates of Deposit (CDs) Fixed-income investments such as bonds offer higher interest rates, making them more attractive to investors.
These investments provide different amounts of liquidity, some require you to hold your money for long periods, while others do not. While these investments are profitable at the moment, there are pros and cons to stashing your money in them.
High-yield savings accounts
High-yield savings accounts Are the deposit accounts that offer the highest Annual percentage returns (APY) than traditional savings accounts. These accounts are risk-free – but only if you choose Federal Deposit Insurance Corporation (FDIC). Or an NCUA-insured bank or credit union and keep your balance below $250,000 per depositor per bank threshold.
APYs on high-yield savings accounts fluctuate with the Federal Reserve's benchmark rate — when the Fed increases that rate, APYs typically rise, and vice versa.
hint: Online banks They usually offer higher interest rates than traditional banks.
Some banks may limit you to six monthly withdrawals when you want to access your money. However, during the pandemic, the Fed waived the six-per-month withdrawal regulation, so you can tap your money as needed.
And don't be surprised when you receive tax forms from your bank regarding your deposit accounts: interest earned on deposit accounts is taxable, so you will have to pay income tax on your earnings.
Certificates of deposit (CDs) and share certificates
Such as high-yield savings accounts, CDs or Stock certificates A type of deposit account offered by banks and credit unions, which is covered by FDIC or NCUA insurance.
These accounts typically offer a higher APY than high-yield savings accounts because they require you to commit a fixed amount of money for a specific period. The duration can range from a few months to many years.
If you cash in early, you'll generally pay back a sum Penalty for early withdrawal Are due a few months of interest or more – be sure to do your research, as longer-term CDs may have higher penalties.
Although CDs are low-risk investments, they are subject to reinvestment risk, or the risk you face when you reinvest your money at a lower interest rate after your CD reaches maturity.
“We're seeing attractive returns on three, six or 12 months from CDs, but the risk is that in six or 12 months when you have to reinvest those returns due if the Fed lowers interest rates, you might reinvest with a lower yield,” he says. Colin Martin, Director, Fixed Income Strategist at Schwab.
To reduce this risk, consider creating a He handed over the CDan investment strategy where you can buy CDs with amazing maturities. This strategy allows you to take advantage of the higher rates offered on long-term CDs while giving you access to cash at regular intervals.
Learn more about CDs:
Money market accounts
Money market accounts Checking and savings accounts are similar – they usually offer a higher APY than checking and savings accounts Checking accounts and easier access to cash compared to savings accounts. Since they are considered deposit accounts, they are covered by FDIC or NCUA insurance.
Like savings accounts, APYs in money market accounts are variable, and typically change with the federal funds rate. You may have to maintain a minimum balance to reap the benefits of a money market account. Otherwise, you may have to pay monthly maintenance fees.
Some money market accounts also have check-writing privileges and a debit card linked to the account, so they're an excellent place to keep short-term savings.
Treasury bills
Treasuries are debt obligations issued by the U.S. government, so they are (mostly) a risk-free investment.
When you buy a treasury, you lend money to the government, which it then uses to finance its expenses. You tie up your money for a specified period, and the government gives you semi-annual interest payments on top of the principal (or the amount you initially invested) when the bond matures.
There are many types of Treasuries – with terms ranging from four weeks if you buy Treasury bill To 30 years if you choose Treasuries. Although you can sell Treasury securities before maturity, they are subject to interest rate risk, meaning their prices fluctuate with interest rate changes.
You can think of interest rate risk as follows: You buy Association At an interest rate of 3%, the following year the market price on the bonds rose to 5%. When you try to sell your bonds at 3%, investors prefer bonds at 5%. The price of your bonds falls by 3% because they are less profitable than 5% bonds, and you also lose money when you sell them.
You benefit from purchasing Treasury bonds because they offer unique tax advantages: Treasury bonds are exempt from state and local taxes, although they are subject to federal tax.
Series I bonds
Unlike the treasury, Series I bonds Offering monthly interest payments and an interest rate that changes with inflation. It's a solid investment choice when prices are high, but not a strong one when inflation is low and interest rates are lackluster.
The interest rate on I-bonds is a combination of a fixed interest rate and an inflation rate that is set every six months.
Series 1 bonds have a term of 30 years, but you can cash them out sooner if you've held them for at least a year. However, doing so could mean missing out on interest payments. If you cash out the bond before five years, you will miss three months of interest.
Since the Treasury Department issues them, they're risk-free investments, and you get tax advantages — you'll have to pay federal taxes on them, but they're exempt from state and local taxes.
Municipal bonds
Municipal bonds, or munis, are issued by state, city, and local governments. When you invest in munis, your money is used to fund projects such as highways or schools. Like Treasury bonds, the duration of munis ranges from one year to more than a decade.
One of the main benefits of investing in municipal bonds is that they are exempt from federal taxes. Depending on whether you live in the state in which it was issued, munis may also be exempt from state and local taxes. Because of their tax advantages, munis typically offer lower interest rates than other types of bonds, such as corporate bonds.
One downside of investing in munis is that they are subject to liquidity risk, which occurs when a security is difficult to sell or trade. Monies can be difficult to sell because the market for selling them is usually small, so they are not a great investment option if you need to access your money quickly.
Like all bonds, munis are also subject to interest rate risk.
Corporate bonds
Companies issue corporate bonds to raise capital. Like other bonds, investors receive regular payments of interest and principal once the bond matures.
These bonds are considered riskier than those issued by the federal government because the U.S. government is less likely to default. Some agencies, such as Moody's, are responsible for rating bonds based on their level of risk – with riskier bonds requiring higher returns.
Since corporate bonds are rated based on a company's ability to pay, they are subject to default risk, which is the risk that a company defaults or fails to make its interest or principal payments.
Corporate bonds are subject to liquidity and interest risks like other fixed income securities. Their price may fluctuate with changes in interest rates, and they can be difficult to trade and sell.
Money market funds
Money market funds are low-risk mutual funds that invest in safe, short-term assets such as Treasury bills, CDs, and municipal bonds. Since these funds are invested in short-term assets, they tend to follow short-term interest rates, which fluctuate with changes in the Federal Reserve's benchmark interest rate.
Unlike Money market accountsMoney market funds are not FDIC insured – although they are considered relatively safe, you are unlikely to lose money by investing in them.
You can invest in a money market fund through a brokerage account, and your money will be easy to access, making it a solid place to save money for a down payment or emergency fund.
Dividend stocks
If you invest in dividend stocks, you receive a share of the company's stock and profits in the form of dividends. Dividends These are the profits that companies pay to shareholders on a quarterly, semi-annual or annual basis.
In general, more established companies, known as value companies, pay dividends because they don't need to reinvest their money to grow, according to Scott Sturgeon, CFP and founder of Oread Wealth Partners.
“As an incentive to shareholders, (value companies) issue dividends, or periodic payments to shareholders. “It's like interest (payments) on bonds,” Sturgeon says. “Because these companies have been around for a long time or their name is known, they can be viewed as “It's a little more conservative.”
However, unlike the interest payments you receive when you buy Treasury bonds, dividends are not guaranteed. During financial turmoil, companies may reduce or reduce their dividend payments entirely.
Instead of investing in dividend stocks of individual companies, you may want to reduce risk by investing in exchange-traded funds (ETFs) or mutual funds that pay dividends. This way, you spread your risk by investing in several companies at once.
When it comes to paying taxes, dividends are taxed at either the ordinary income tax rate or the capital gains rate.
Takeaway
Some cash equivalents – such as money market accounts – and fixed-income securities offer excellent returns due to interest rate hikes by the Federal Reserve. While these investments may provide generous returns, these returns may vary with changes in the Federal Reserve's benchmark interest rate, making many of these investments subject to reinvestment risk.
“We're trying to get (customers) not to just sit in cash right now. We know it's attractive, but when you think about it from a longer-term standpoint, we encourage them to think about alternatives, so they're not so dependent on what the Fed does or doesn't do.” He does it over the next few years,” says Martin.
Fixed income and cash can help reduce volatility and preserve capital in your investment portfolio, but pouring all your money into it may undermine your long-term financial goals. Instead of striving for high returns, you should focus on creating a portfolio—composed of stocks, bonds, and cash—that matches your liquidity needs, risk tolerance, and investment horizon.
