It’s no secret that savings accounts are struggling to entice new customers. With every week that passes, savings account rates are falling lower and lower. Online banks have proliferated the marketplace and boast more impressive rates overall than the bricks-and-mortar institutions, but even their yields have been anything but show-stopping. This is all by way of saying, it’s no wonder there are so many alternatives to the savings account these days. You owe it to yourself and your emergency fund, to know what they are, where to find them and how to take advantage of them. So we’ve put together a list of what we believe to be the top five alternatives to investing in online savings accounts.
1. CD Laddering
This is a fascinating and somewhat complicated formula that stages your CD investments to maximize rates and compounded returns. A CD ladder allows you to invest in different length CD’s, never having all of your money locked up for a long period of time. The below table shows how you would invest $20,000 in five different CD’s and their respected APY’s.
Each year one of your CD’s matures, you simply reinvest it into a 5-year CD. This way, you will have one CD that matures every year and should you have an emergency where cash is required, you won’t face a penalty for pulling money out early. The small sacrifice you are making here is that in the initial five year period you are not earning as high an interest rate as you would if you simply invested all $20,000 into a 5-year CD to start.
2. Person-to-Person Lending
Also known as peer-to-peer lending, social lending or P2P lending, this innovative concept pairs those who want to borrow with those who want to lend, bypassing the bank as middleman. Using the Internet, the two parties meet auction-style and the party offering the best rate wins. There is no overhead, which offers obvious benefits and ironically, despite the lack of face-to-face contact between parties, there is the ability to have a more personalized relationship than the big banks can offer. Another iteration of person-to-person lending is community lending, in which multi-person groups work together on borrowing/lending transactions.
The two most well-known P2P lending companies around are Lending Club and Prosper. If you invest you’re money wisely, you can see a return five times greater than any online savings account can provide. The interest rates on the loans you offer are split into different classes so the higher the interest rate, the greater risk you take that the borrower will default. There were $118 million in person-to-person loans in 2005; $647 million in 2007; and a projected amount of $5.8 billion this year. With many banks tightening up their lending policies because of the economy, consumers are turning to other consumers for loans, which should keep interest rates high.
3. Bond Mutual Funds
Investing in bonds and other debt securities has been an age old conservative way to receive steady income on an investment. Unlike other mutual funds where your money is moved around in search of a better “deal,” your principal stays put in a bond mutual fund. You’ll receive monthly dividends that include interest payments on the fund’s underlying securities plus any capital appreciation in the prices of the portfolio’s bonds.
Bond funds are usually selected for diversification purposes and income generating ability, as they tend to pay higher dividends than money markets and many savings accounts. They are safe but not entirely without risks. A bond fund is spread out amongst many bonds, thus protecting it from the misfortune of a few languishing performers. Certain bond funds may also be exempt from federal and/or state taxes, adding to its appeal as a money-maker.
There are three major kinds of bond funds.
- U.S. Government Bond Funds – are the safest of its kind, as their securities are fully backed by their issuer, the U.S. government. The only real risk with these funds are the ups and downs of interest rates and inflation.
- Municipal Bond Funds – are investments in debt securities paying for local public projects, like bridges, highways and schools. People with high incomes gravitate to municipal bond funds because they are exempt from federal taxes and possibly state taxes, too. Because they are backed by the government, they have a high credit rating but they carry a little more risk than U.S. government bond funds because municipalities can (and some do) declare bankruptcy.
- Corporate Bond Funds – are made up of bonds issued by private companies and are, therefore, not backed by any government entity. As such, they are riskier but they can be much more financially rewarding than other bond types. A subset of corporate bond funds is the investment-grade corporate bond fund, which invests in only very stable, creditworthy companies.
Other, more obscure bond funds include:
- Zero-Coupon Bond Funds
- International Bond funds
- Convertible Securities Funds
- Multi-Sector Bond Funds.
4. Paying Down High-Interest Debt
One of the most intuitive, yet overlooked ways to save money is to eliminate your debt. There is an ongoing discussion about which debt to pay off first: the one with the highest interest or the lowest balance. After much analysis, the answer is: pick a debt, any debt. Action of any sort is a win. Another way to pay down your debt is to consolidate higher debt credit cards with lower rate credit cards. Finding a credit card with a 0% balance transfer was a lot easier a few years ago but if you look hard enough, their still out there.
If you don’t have the credit score to acquire a quality balance transfer credit card, try to pay your balance off as fast as you can. Paying the minimum payment each month is the sucker’s play so even adding an additional $10-$15 will go a long way in the end. Keep that mountain of debt from piling up any higher by living below your means for as long as it takes.
You’ll find some who suggest cashing out some of your savings or investments to pay down your debt, but that’s a very personal decision dependent on your situation. If you’re paying on a 6% loan and are only receiving 1% of interest from your online savings account, you can see why so many suggest making this move.
5. High-Yield Money Market Accounts
If you want to one-up the yield on your savings account, open a money-market account, or MMA. MMA’s are like a mutual fund in that they own a lot of different securities. More and more people are doing it because the yields are too hard to pass up. They typically pay around 1% more than the national savings account average. Make sure to look at the annual percentage yield, or APY, to determine the exact rate of return. This is always a variable rate, which means it can change at any time; for better or for worse. You’ll also likely be held to a minimum balance and will encounter more fees for withdrawals or transactions with a high-yield account.
The best of the bunch are found at online banks, so you’ll also have to get comfortable with opening and managing your high-yield account online. With so little overhead, online banks can pass the savings on to you. Ally Bank and Discover Bank currently offer APY’s similar to that of their savings accounts but in-time you can expect their MMA rates to be higher than their savings account rates.