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Where You Are...Part Two
Where to put your savings is determined mostly by your time and your disposition. Time is the factor that is mostly on our side, no matter how late you decide to start saving. But let's start from the beginning.
Many older investors have a real aversion to risk. While the rewards are continually touted as worth the possible downside of risk, the rewards are often shunned because of that "downside". Savers, who from now on will be referred to as investors, work hard for their money and feel a need for liquidity. This means that if they are saving, they want to be able to access their cash for emergencies. And this is not a bad idea. Time and again, the theory of having 6 months wages saved in the event of an emergency pops up as the first step towards starting to invest in your future. It is a great idea, but between you and I, saving six months emergency cash may be the single hardest thing you ever attempt. BlueCollarDollar readers live by the squirrel principle. We stash a little at a time, doing it as often as possible. But to accumulate six months of spare cash might take longer than it is worth.
The steps toward saving for your future involve the kind of discipline that pulled you out of debt. A little bit at a time is by far the best investment in your future. But where do you stash the little bit you can?
Banks have always been the safest place to stash your cash, and safety will always result in low returns in the form of minuscule interest rates. Folks will use this as their most accessible form of liquid savings. The risk is almost non-existent with your money coming under the protection of the federal government. Banks also offer a longer term savings vehicle with somewhat higher rates based on the length of time you deposit your money. Certificates of Deposit while better interest wise than traditional passbook savings, have little risk involved and provide the investor with a determined amount of savings.
Next up are the ever sensible bond. Savings bond. These come in two flavors: the "I" or Inflation Bond and the EE Bond.
The I Bond is sold at face value meaning that if you purchase one at $100, you pay a hundred dollars, whereas EE bonds can be purchased at half their face value. $50 gets you a $100 bond with interest paid on the bond when it is cashed. The return also varies greatly because the interest paid on them is calculated differently. On an "I" bond, the interest rate is part fixed rate which is currently at 3.4% and inflation rate which is calculated every six months. This inflation rate is based on the Consumer Price Index which at last tally stood at 3.58%. Interest on an "I" bond is added monthly and compounded every six months. These bonds pay interest for thirty years and this interest is more or less guaranteed for that time period. It's value may not increase during deflationary times (the opposite of inflation where prices fall instead of rise causing a slower growth but never decreasing value) but the rate is steady.
EE bonds pay a rate of 5.19% and this interest rate is tied to the Treasury yields on the five year bond. These bonds have some tricky rules hidden in older issues of these instruments, but still remain the most popular. Studies have shown that holding "I" bonds over the last fifteen years or so would have done you better that EE bonds. Both are tax free on the state level and if these are used for education, can also have additional tax benefits. If you are interested in using these stalwarts of conservative investment you can download an application here.
But still you can't help but put bonds into the category of an investment choice of generations past. They are solid type investments backed by the faith in the federal government. In a later edition of this letter, we will discuss bond funds which are mutual funds that invest in bonds and treasury securities. These funds have come under some pressure lately as inverted yield curves have come into play. Like I said, it is a whole topic unto it self.
According to the Investment Company Institute , a company that tracks cash flows for much of the mutual fund industry, has recently determined that money market accounts have now swelled to $1.7 trillion with one in every seven "liquid" dollars parked there for safe keeping. The ICI was created in 1940 as a sort of watchdog group with over 7800 mutual funds that have agreed to adhere to certain rules and principles above and beyond what the SEC (Securities and Exchange Commission) has laid out.
Money Market Funds, whose number now stands at 1027 available, invest in short term, high grade securities whose value is determined by something called the "spread". This spread is determined by the difference between what your cash would earn in a typical savings account and what the money market fund would pay. This gap has been gradually widening in recent years attracting more and more individual investors along with the large institutional types. This yield is currently at around 5.4% for a taxable fund, 3.2% for tax free funds. Saving accounts are floating in the 1.5% range.
Money market accounts have become much more attractive of late by offering more services to their investors including check writing privileges, and in some cases online bill paying. These are features that you would expect at a normal banking institution.
This convince can often be so alluring that investors park too much of their money in the safety of these funds missing out on the possible gains that they would receive had they had their money in some sort of stock fund.
Once again the cost of investing in a good money market account should be as inexpensive as possible. Keep within the 0.5% range of assets and you will do just fine. Just remember that investments with minimal risks also allow for minimal returns. As of this writing, The Vanguard Admiral Treasury (symbol VUSXX) has a yield of about 5.56% making it one of the best in the industry.
One last note about money market accounts is their taxability. Whether they are tax free or taxable, they both have similar investment performances. Funds that invest in Treasuries are exempt from state and local taxes and for that reason alone, might be better for some folks depending on tax rates.
Who invests in mutual funds? It isn't who you might think.
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