Hey, buddy, where’s your cash?
Back in 2005 (queue up “Hollaback Girl” and “Since U Been Gone”), you could put your money in a high-interest savings account and earn 5% or more, and FDIC insurance made it as close to risk-free as anything ever gets in finance.
Well, you know what happened next. In 2008, when the financial world fell apart, central banks around the world dropped interest rates to try and boost the economy.
When I started writing this column, in 2009, people were saying interest rates were so low they couldn’t go any lower. Then they went lower.
For years I’ve been singing (to the tune of “Since U Been Gone”) the praises of Series I US Savings Bonds, or I-bonds for short.
Now that some interest rates are starting to go up for a change, are I-bonds still a good choice for your cash savings? Read on.
Note: I’m only looking at FDIC-insured (or equivalent) products here. Yes, I know about Lending Club, bond funds, REITs, MLPs, and other products that let you take risk in the pursuit of a bigger payoff.
All are appropriate additions to a portfolio in the right situation, but they’re not savings account alternatives.
The I is for inflation
Here’s a brief refresher on how I-bonds work and why you might want to own them. (I own a bunch of them.)
- I-bonds are issued by the US Treasury and can be purchased online at TreasuryDirect.gov. You can buy up to $10,000 per person per year, in any denominations you want above a $25 minimum.
- I-bonds pay an interest rate equal to the rate of inflation, as measured by the Consumer Price Index. This measurement includes the price of food, energy, housing, health care, and a bunch of other stuff. It may not match your own personal rate of inflation, but it’s a pretty good measure.
- The I-bond interest rate adjusts every six months and is currently 1.18%. Based on recent inflation reports, the rate will probably go up in November, but that’s a guess, not a guarantee.
- I-bonds have some nice tax features. You don’t have to pay tax on them every year, like a CD—only when you cash them in. They’re exempt from state and local income tax. And if you use them to pay for college, the interest isn’t taxed at all.
- You have to hold onto an I-bond for at least a year. And if you cash it in before 5 years are up, you’ll pay a small penalty (3 months interest).
I-bonds have occasionally paid much higher interest than CDs. For a six-month period in 2011, for example, they were paying 4.6%. Right now, no such luck.
About those CDs
According to DepositAccounts.com, with a $500 minimum investment, the best 1-year CD rate is 1.05% and the best 5-year rate is 2.0%.
Compared to I-bonds, CDs are less tax-advantaged and are not inflation-indexed, which makes them slightly riskier.
If you want to get your money out of a CD before the term is up, you’ll pay a penalty, typically 6 to 12 months interest.
I also took a look at online savings accounts, which obviously offer the most flexibility: you can transfer money in and out any time without…wait, why am I explaining how a savings account works?
The best interest rate you can get right now is about 0.9%. Banks can adjust their savings account rates up or down any time, so unlike a CD, that rate isn’t guaranteed to last more than a month.
Still, you don’t pay much for the added flexibility. On a $10,000 deposit, over one year, the difference between 1.05% APY and 0.9% APY is $15.
Getting clippy with it
Are you a coupon-clipper or a credit card rewards maven?
If so, you’re presumably comfortable with the idea of jumping through a few hoops to save more money. For you, I have a couple more savings ideas.
Reward checking accounts (sometimes branded as Kasasa checking) pay high interest (up to 4%, although 2% is more typical) on a limited balance (usually $10,000 or less) if you play along with their requirements and restrictions.
These usually include a minimum number of debit transactions per month, direct deposit, and some combination of e-statements, online banking, and online bill pay.
Some banks offer a hybrid savings account/prepaid debit product (one brand is Mango) that pays a very high interest rate (6%) on a balance of $5000 or less.
The hoops for this one are flaming: you have to set up direct deposit, juggle the prepaid and savings account components, and pay a monthly fee. But the high interest is real.
If you want to give it a try, Harry Sit of The Finance Buff blog explains how to do it.
Why I still love I-bonds
Here’s why I still think I-bonds are your best default cash savings tool.
- They’re low-maintenance. Once you’ve set up your TreasuryDirect account, it’s easy to buy I-bonds any time, and unlike CDs, you don’t have to roll them over, because you can hold them for up to 30 years. And you don’t have to report the interest on your tax return until you sell.
- The interest rate is always competitive. Yes, you can probably beat I-bonds by scrupulously shopping around for the best CD rates. But because I-bonds track the inflation rate, it’s like having the government shop around for a pretty good (and sometimes the best) rate every six months, at no charge.
- Cashing in I-bonds is just convoluted enough to discourage impulse spending. It’s not hard, by any means, but you have to log into TreasuryDirect, select which bond to cash in and how much to withdraw, and possibly pay a small penalty. It’s enough to make you pause and say, nah, I can keep this money in savings for now. Which is, of course, exactly what savings bonds are designed for.
That said, if you’ve tried a more creative method of upping the yield on your savings, I’d like to hear about it.
Matthew Amster-Burton is a personal finance columnist at Mint.com. His new book, Pretty Good Number One: An American Family Eats Tokyo, is available now. Find him on Twitter @Mint_Mamster.