Your Emergency Fund and Savings Goals
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YOUR EMERGENCY FUND AND SAVINGS GOALS ARE LESS THAN TWO YEARS AWAY
If you are planning to spend your savings on, say, a new car or home in the coming year or two, safety should be your biggest concern. You need to keep your savings in a safe place where you can get to it quickly without paying a stiff withdrawal penalty. You could go with a plain old savings account at a bank, savings and loan, or credit union. These accounts pay interest, but usually not much. The average savings account has been paying out a little more than 2% in interest in recent years. That rate assumes you keep enough in the account to earn interest at all. Some banks stop paying interest and even begin socking you with account-maintenance fees if your balance dips below $200 or $500 or so. True, you money is insured by the Federal Deposit Insurance Corporation. (Credit unions are insured by the National Credit Union Insurance Association; look for the NCUIA sticker in your credit union’s window). Should your bank, S&L, or credit union fail, you’ll be covered against a loss of up to $100,000. That limit applies to all accounts in your name, so be sure your total balances in all accounts at any one institution are less than $100, 000. It’s also true that you can take money out of these accounts without cost or penalty.
But you can earn more money without giving up much and by staying at the same bank, S&L, or credit union. You do so by stepping up to a money-market deposit account. When savings accounts were yielding 2%, money-market accounts were paying 2.6%. No great shakes, but a better deal nonetheless. You need to keep more money in these accounts to get the best returns, however. Money-market accounts typically demand minimum deposits of $1,000 or more. They also somewhat restrict your ability to retrieve your money. The accounts limit your withdrawals to a maximum of just six a month. Money-market accounts, however, do permit check writing, but you can write no more than three checks a month (other than ones made out to yourself or to “Cash”). Don’t limit yourself to local institutions, however. You can frequently earn two percentage points more on your savings by opening a money-market account at one of the nation’s top-paying, federally insured banks or S&Ls.
If you’re willing to sacrifice federal deposit insurance in exchange for a higher return, by all means look into opening a money-market mutual fund account instead. These funds, which invest in short-term corporate and government IOUs such as Treasury bills, often pay two percentage points more than the average rate on money-market deposit accounts. The funds usually demand you keep a balance of $5,000 or more, but you can write checks with them. Like other types of mutual funds, money funds are made up of shareholders. But unlike stock and bond funds, whose share prices fluctuate, the price of money funds generally remains constant at $1 a share. So if you deposit $5,000 in a money fund, you are buying 5,000 shares at $1 apiece.
There’s really no need to lose sleep about not having federal deposit insurance on a money fund since the last thing a money fund manager wants to do is cause his shareholders to lose money. Until recently, money-market mutual funds had a near perfect track record: no one had ever lost a dime in one of these funds. In 1994, however, one money fund that was open only to institutional investors (such as banks) did suffer a drop in its share price. To boost its yield, the money fund had invested heavily in complex financial instruments known as derivatives, which backfired when interest rates rose throughout the year.
Derivatives are financial products whose value is based on, or “derived” from, yet another financial product or benchmark, such as long-term interest rates or a commodity price index. Although individual money-market fund customers generally haven’t lost any principal because of derivatives, rising interest rates sparked whole-sale carnage in the derivatives markets in early 1994 and severely cut into yields of some money funds. Roughly a dozen money funds, including Pacific Horizon Prime Fund and Zweig Cash Fund, were bushwhacked by derivatives-related losses. In every case but one, investors in such money funds were made whole, as fund and plan managers dug into their own pockets for cash to keep net asset value from falling below the $1 standard.
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One Response to “Your Emergency Fund and Savings Goals”
“Should your bank, S&L, or credit union fail, you’ll be covered against a loss of up to $100,000.”
Just FYI, thanks to the so-called Bailout Bill, that limit has been increased to $250,000 until at least December 31, 2009. The insurance increase applies to both NCUA and FDIC protections.
By
shannon (Who am I?) on Nov 28, 2008