The best investment strategy requires the distribution of investments across different asset classes to mitigate risks and optimize portfolio performance.
As an investor, you need to know about deposit options for fixed-income securities and stocks. In this article, you’ll discover the pros and cons of each so you can formulate the best investment strategy.
The Federal Reserve reduced interest rates in 2020 and in January 2021 announced they would keep them low. Hence, investors should reconsider their deposit options to obtain good returns.
Depending upon your desired risk/return profile, you can select one of these deposit options to earn optimal earnings:
Online Savings Accounts
These are safe places to deposit your money in return for moderate yields. Online accounts offer returns much higher than traditional accounts. Since online accounts do not require physical branches, their expenses and overheads are much lower.
Therefore, financial firms can offer higher yields on these accounts. These returns often reach an excess of 2% while the national average for conventional accounts stands at just 0.05%. There is a significant difference between the two rates.
Online savings accounts are an excellent choice for emergency funds. An emergency fund is necessary since there is a risk of losing income through illness, disability, redundancy, or other factors. If you have lost your income, the emergency fund should be large enough to cover six to 12 months' worth of necessities.
Your emergency fund can remain safe in the online savings account and even grow.
Money Market Accounts
There are also other deposit options that offer better features compared to online savings accounts.
Money market accounts (MMAs) are a safe place to deposit your money because they are usually FDIC-insured. They also offer great features, such as good yields, checkbooks, and easy access to cash.
MMAs offer interest rates comparable to online savings accounts. But they usually have higher minimum deposit requirements. They also offer checkbooks for quick access to funds. With an MMA, you can write a limited number of checks each month. Savings accounts do not provide checkbooks.
Since the interest is compounded daily, you may enjoy higher yields from MMAs.
The major drawback is that the minimum deposit requirement often ranges from $2,500 to $3,000. You must pay a monthly fee if your deposit goes below this amount. A significant part of your yields may be lost if your balance dips below the minimum requirement.
You can also execute a maximum of six transactions each month with an MMA. Some firms allow just three transactions per month. So MMAs are best for savings and cash reserved for emergencies. Therefore, MMAs are not suitable for everyday purchases.
Money market accounts also offer returns lower than Certificates of Deposit (CDs). However, the higher-earning power of CDs comes at the expense of liquidity.
Some money market accounts offer high interest rates. They often offer promotional rates, which disappear after a few months. So ensure that the yield is a permanent rate rather than a promotional offer.
Money Market Funds
Money market funds allow investors to put their money in different money market instruments. They are safe securities. But they also offer a relatively low interest rate.
These funds were introduced in the 70s and have now grown to almost $3 trillion in aggregate.
Money market instruments typically require an investment of at least $100,000. That’s because they are offered to big corporations, government bodies, and banks. Money market funds purchase these investments and then allow the public to buy shares.
Money market funds invest in 3 basic instruments. These include:
- Federal government-backed U.S. treasury bills
- Commercial papers
These are safe investments. Usually, CDs are FDIC-insured, and commercial papers are issued by major corporations with high prestige.
Besides high financial safety, money market funds also provide easy access to invested cash. They don’t typically have a minimum deposit requirement. If you withdraw funds early, you won’t suffer an early withdrawal penalty, unlike a CD. However, CDs offer a higher rate of return.
The major disadvantage is the modest interest rate, which can average between 2 to 2.5% yields. The inflation rate can easily exceed this percentage. There, your deposit will lose value over time.
However, this moderate yield can be attractive during recessions when stock markets are falling. Also, money market funds are not FDIC-insured.
High-Yield Reward Checking Accounts
These accounts may offer as high as a 5% yield, in some cases, which is impressive for liquid accounts in this era of low-interest rates. This is higher than many long-term CDs.
There is another reason they may be a better option than long-term CDs: Interest rates are at a record low, and rates can increase substantially soon. Due to this possibility, there is a significant risk of lost earnings with long-term investments.
Yields on high-yield reward checking accounts are more than other savings accounts. Many also refund fees on ATM transactions for ATMs anywhere in the country, and they rarely carry monthly service fees. There is also a rich assortment of high-yield accounts, which are offered by credit unions and community banks in all states.
The major drawback is that you often need to execute at least 10 debit card transactions each month. If you fall short, you will receive a low interest rate well under 1%. Your ATM fees will also not be refunded.
You must carry out the mandated number of debit card transactions to avoid being penalized. This may cause reduced credit card use, which can diminish your rewards. Debit cards also offer less protection compared to credit cards.
Some customers have tried to resolve this issue by using debit cards only for small purchases. However, some banks are checking transactions and threatening to close accounts if debit card transactions are too small.
The minimum balances and initial deposits are usually non-existent or low. However, there is often a balance threshold beyond which the interest rate is minuscule. Often, this limit is $25,000. This may be a significant drawback for those who wish to keep more substantial amounts.
Also, you’ll probably have to make at least one deposit each month. You may also have to follow other requirements.
Banks can reduce this threshold, too, besides lowering the interest rate.
An example of a high-yield account is offered by Consumers Credit Union. The 4.09% interest rate does not have a minimum balance requirement, however, the rates decrease once you hit the $10,000 maximum threshold, so if you have more than $10,000 in your checking account, you’ll want to look for APYs that increase with your balance.
U.S. Treasury Bills
Treasury Bills are one of the most popular financial instruments worldwide. The U.S. federal government issues debt instruments in bills, notes, and bonds with different maturity periods. Bonds mature in 10 years or more, notes in two to seven years and bills can take up to a year.
Since these instruments are backed by the federal government, there is no risk of default. The federal government can issue enough dollars to repay the debt on treasury instruments.
Treasury Bills (or T-Bills) are offered in $1,000 denomination. They can mature anywhere from a few days to 52 weeks. Longer maturity dates result in higher interest rates.
Investors purchase T-bills at a discounted value, which is less than the face value. But when the bill matures, they receive cash equal to the face value. The difference between the purchase value and face value is the interest earned by the investor.
Treasury bills offer high liquidity since they have a large and active market. They also provide some tax benefits. Earnings on T-bills are not taxed at the state level although federal taxes apply.
However, they also offer relatively low returns as they are a low-risk investment. Corporate bonds provide higher yields. But they also carry a greater risk of default.
Treasury bills are also less attractive as investors can lose value if inflation is higher than the interest rate.
Certificates of Deposit
CDs are one of the safest investment tools. CDs can be insured up to $250,000 by the FDIC. No one has ever lost money on FDIC-insured CDs. Credit union CDs are protected by the National Credit Union Association.
Interest rates are higher for longer CD maturity dates. The maturity dates of CDs can vary greatly. Maturity time frames can be as low as three months and as much as 10 years. Investors can easily find a CD whose maturity date matches their needs.
The yield remains consistent throughout, no matter what the prevailing interest rates. CDs, therefore, offer very predictable returns.
The money stored in CDs is not readily accessible. Hence, they are an excellent deposit medium for your savings.
The main drawback of CDs is low liquidity. Usually, you will have to pay penalty fees for early withdrawals. Therefore, CDs may be problematic if there is a sudden emergency where you need money quickly. You should, therefore, not invest your emergency fund in CDs.
But there is a way in which you can increase liquidity and optimize the aggregate interest. You can create a “CD Ladder” by purchasing CDs with different maturities such as three months, six months, one year, and so on. Short-term CDs will give you quick access to cash, while long-term CDs offer a higher interest rate.
There is also the risk that high inflation value will erode the value of your investment. Since the interest percentage is not high, inflation effects can overtake the yield, resulting in a loss of value.
Although long-term CDs offer higher interest rates, they also pose a risk. If you invest in a long-term CD and interest rates rise a few months later, then you will suffer lost income opportunities. This is because you cannot withdraw before maturity without incurring an expensive penalty.
Once you have deposited enough money in online savings accounts or other high-interest accounts described above, you can look towards other options for higher returns.
Stock markets historically have offered around a 10% average annual return. They have higher yields and higher risk compared to online savings accounts.
An IRA account is one of the best starting points for such investments. These accounts offer attractive tax-savings benefits.
Opening an IRA account is very simple. You can open one in as little as 15 minutes. You just need to provide basic personal information like your social security number and date of birth.
An IRA can be a better option than a company-sponsored 401k because it offers more investment choices. So besides your company-sponsored 401k, also invest in an IRA account.
You can open an IRA account at an online brokerage to select your own investments. You may choose from low-cost investments, which include exchange-traded funds and index mutual funds.
Here are some of the best brokerages:
Ally Invest IRA
IRA investors can benefit from $0 annual fees, low commissions, and no minimum amount requirements. The brokerage provides an intuitive web-based platform and in-depth research.
TD Ameritrade IRA
This brokerage offers a wide assortment of research tools for both investment and retirement planning. IRAs have $0 opening balance. The exchange-traded funds (ETFs) are commission-free, and mutual funds have 0 transaction fees. The firm offers a free paper trading account and educational resources for investors to develop their trading skills.
Schwab Brokerage IRA
This eminent firm provides a wealth of commission-free ETFs and 0-transaction-fee mutual funds. There are no inactivity fees, and the mobile app is a robust platform for trading. Investors can benefit from high-quality, in-depth research and analysis.
Mutual funds and ETFs are essential financial tools at your disposal, which can offer returns much higher than fixed-asset securities.
An ETF is a package of securities, which you can purchase or sell via a brokerage firm on the stock exchange. ETFs are provided on all imaginable asset classes. These range from common stocks to alternative assets, such as currencies and commodities.
Some ETFs are also structured so they may not be subjected to tax on short-term capital gains. Hence, they can provide tax benefits as well to maximize your net earnings.
Aggregate ETF investments are estimated to be $1 trillion. Almost a thousand different ETF products are being traded at U.S. stock exchanges.
ETFs are one of the most valuable and versatile financial products created in recent years. If used wisely, they can enhance portfolio performance and help investors achieve their financial objectives.
ETFs have a ticker symbol just like stocks. Therefore, intraday data is easy to obtain during trading hours. They can be traded in the same way as stocks while stock exchanges remain open.
ETFs combine the features of stocks and index funds to obtain the best of both. They are also relatively economical since management fees are low.
The original purpose behind ETFs was to create a trading vehicle, which can reflect the price of various indexes.
ETFs are relatively low-risk since they follow several stocks rather than just one.
A mutual fund is an investment vehicle, which gathers funds from several investors to diversify their portfolio and enhance their purchasing power.
Investors can create a much more diversified portfolio collectively than they could on their own.
There are basically two types of funds:
- Actively Managed Funds. Financial professionals select different stocks to fulfill investor objectives.
- Index Funds. These simply follow indexes such as the S&P 500.
Actively managed funds, in particular, can bring rich rewards for investors if they are controlled by experienced financial professionals with a high level of expertise.
But index funds can offer low operating costs since they do not employ expensive services of professionals. These funds can be very convenient for investors who don’t have time to follow stocks.
As you can see, there are plenty of options for choosing your best investment strategy. The investment options described above are critical tools for optimizing yours. Make sure you find a balance between risk and reward, and also consider liquidity.