I have a confession to make. Every time I look at my bank statement, I feel cheated.
Remember being taught about compound interest and savings as a child? Put some money in the bank, earn interest, and the money grows. Well, that stopped happening around the time of the 2008 Great Recession when interest rates fell to zero. Instead of the money growing, you started earning less than 1%, perhaps only a few pennies each month.
Here’s the good news. Interest rates are finally moving higher.
The bad news? Your bank thinks you don’t know that, so they’re still likely paying close to zero interest.
Some caveats: it can make sense for investors to keep cash in their investment accounts, even at lower yields, as a buffer for trading frictions or fees. And, of course, keeping a balance in the bank is advisable for an emergency fund and covering everyday expenses.
But there are other ways to earn a higher yield on your cash.
Here is one of the banks’ favorite ways to earn more yield on their cash: investing in Treasury Bills.
A Treasury Bill is an interest-bearing instrument guaranteed by the US government. They come in increments of $100 and are issued at a discount through the US Treasury at TreasuryDirect.gov, or they can be purchased on the open market through a brokerage firm like Fidelity, Schwab, E*Trade, or Vanguard. They range in maturity (timeframe) from only a few weeks up to 1 year.
Here’s how it works: say you purchase a Treasury Bill with a $1,000 face value, also known as the par value, with a 1-year maturity. It is issued at a discount depending on market interest rates. The difference between the discount and the par value is the interest you earn. Let’s say you put in $970, and one year later the Bill “matures” at $1,000, so you earned about 3% in interest.
Currently Treasury Bills, or T-Bills, are yielding about 3% for a 1-year maturity, or slightly less than 3% for under a year.
Unlike a bank account, T-Bills trade on the open market, so if you need to sell the T-Bill before maturity, the value could be higher or lower than what you originally paid. But if you hold it until maturity, the par or face value is guaranteed by the United States and is generally free from state income tax. T-Bills are still subject to federal tax.
High Yield Savings Accounts
Many banks have started offering high yield savings accounts to customers who are willing to jump through a few hoops. They operate much like a regular savings account, but are usually only offered online rather than in a bank branch.
Here are a few examples of high yield savings accounts and their interest rates (as of August 2022):
Marcus by Goldman Sachs: 1.7%
Ally Bank: 1.6%
Capital One: 1.5%
Different banks may impose fees or restrictions on how often you can withdraw cash, but this is generally a good way to earn more interest on idle cash.
Money Market Funds
Money market funds are a type of mutual fund that invest in short term bonds and debt instruments with low credit risk. While they aren’t completely immune to risk, they are typically priced at $1 in the absence of extreme market conditions. That means stability for your principal and usually a higher yield than a bank account.
Money market funds can be purchased through a brokerage account, and every brokerage firm offers different funds with varying fees. The higher those expenses, the less they will generally pay in interest for the same level of risk.
For example, the Vanguard Federal Money Market Fund (Symbol: VMFXX) is yielding slightly over 2% as of the date of this article and has an expense ratio of 0.11%.
Some money market funds are designed to pay interest tax-free at the federal level by investing in municipal bonds and other tax-free securities. That can be helpful if you are in a high tax bracket.
Short Term Bond Funds
Short Term Bond Funds carry slightly more risk and are not immune to losses, but they may pay a higher interest rate for those willing to take some risk.
For example, the Schwab Short-Term Bond Index Fund (Symbol: SYSBX) has a 30-day SEC yield of 3.27% as of 8/12/22. However, it’s actually fallen in value by over 3% this year, after including the interest paid, because interest rates have soared and impacted bond prices. If interest rates remain stable, the fund should earn a return similar to its yield. However, if interest rates fluctuate up or down, the fund’s returns will vary due to price appreciation or depreciation.
Rising interest rates generally hurt bond returns in the short run, but help in the long run as bonds begin to pay more interest.
Series I Bonds
For investors concerned with inflation eroding their principal, Treasury Series I Bonds can be a good complement to their portfolio. The downside is that purchases are generally limited to $10,000 per person, per year, and they must be purchased through TreasuryDirect.gov rather than through a brokerage account.
The initial yield is attractive right now based on high inflation rates (9.62% for bonds purchased between May and October 2022), but the interest rate will likely fall in the future if inflation falls. Interest is tax-deferred until the bonds are redeemed, and there is a 3-month interest penalty if the bonds are cashed in the first 5 years. They cannot be redeemed for at least a year after purchase. Interest is generally free from state income tax but still subject to federal income tax.
There are now more and more options for investors who want to earn a higher interest rate on their cash. Even more options include Certificates of Deposit (CDs), switching to a different bank or credit union, or investing in higher risk assets like stocks and bonds.
But especially for investors with excess cash sitting idly, it’s worth shopping around.