Banking 
10
comments

Best Money Market Account (MMA) Rates

(Updated 9/1) In the world of banking products, you are always trading off interest rate for flexibility. Typically the higher the interest rate, the less flexible the account. Take CD rates for example, they are often higher than savings accounts and they are less flexible. You decide how long you’re willing to keep your money locked up and then pick a bank that offers the best rate for that term. If you wish to get your money early, you pay penalty. On the other end are checking accounts. Checking accounts have the worst interest rates but offer the most flexibility. You can get your cash whenever you want it, write as many checks as you’d like, and visit your own ATM without penalty. For that flexibility, you earn very little, if any, interest.

Where does that leave money market accounts?

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 Banking 
18
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Opening an Everbank Yield Pledge Money Market Account

EverBankAfter closing my Emigrant Direct account last week, I figured I’d add to my paperwork and open up a new bank account! This time I turned to a bank I’ve talked about in the past but never dealt with personally – EverBank. They have all the characteristics I look for in an online bank – FDIC insured, competitive interest rate, and informative website. They’ve been been in business for many years, as a mortgage lender, before they started taking deposits in 1998 (when they were FDIC insured). Since then, they’ve won a ton of awards such as Money Magazine “Best of the Breed” in 2007 and Kiplinger’s “Best Checking Account” in 2006. Most importantly, they don’t appear to be too affected by the credit crisis… all good things, so I opened an account today.

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 Banking 
13
comments

The Basics of Banking Explained

This is the first edition of our Personal Finance Foundation Series where I discuss the very basics of foundation-type personal finance topics. The topic of this post is Banking.

I was fortunate that my first real experience with banking was with a local credit union. Credit unions are really great about welcoming new members and educating them about everything. Commercials banks, while still cordial, simply don’t offer the same types of services that credit unions do. My mom and I opened a joint banking account a local credit union when I was fourteen and I was excited to even have a laminated blue card with my account number and credit union phone numbers! I still have the card in my desk drawer, I still have the account open, and it was a nice warm and welcoming introduction to the banking world.

That, however, seems to be atypical. Many people are introduced to the banking world either through the nastiness of credit cards or by walking into the antiseptic branch of a major bank. You open an account, direct deposit your paycheck, and feel like a number in a database. There is no education, no explanation, just an assumption that “you’ll figure it out eventually.” Well, unfortunately that isn’t enough because “figuring it out” usually results in you being dinged on fees so let’s start from the basics and go through what banking is.

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 Banking 
4
comments

Certificates of Deposit: Pros & Cons Weighed

Hiding Piggy BankFor the last ten years, certificates of deposit have gotten a terrible rap. Interest rates were low compared to the blockbuster returns of the stock market and you were locked into that CD for 12-, 24-, 60- months, all making it an unappealing investment option. For many, CDs only ever came up in financial conversation when you were talking about laddering an emergency fund because protecting your principal was your number one goal.

Well times have changed and CDs, with their FDIC insurance, have once again come into vogue as investors have plowed hundreds of billions of dollars into the CD market in recent weeks. I personally use CDs to help increase the rate of return on my savings, specifically in laddering my emergency fund, and below I will list three good reasons you should save with CDs and three reasons why you shouldn’t.

Three Good Reasons

Certificates of deposit are safe. They are FDIC insured up to $100,000 ($250,000 through December 2009) which makes the principal safe from loss. With the stock market as volatile as it has been the last several weeks, protection of principal is almost as important as appreciation. With the markets down double digits, earning what was once a “measly” 4% APY on a CD really looks good right now since it beats the market by a considerable margin! The best CD rates are now in the mid-4% APY range so they are at least competitive with other options.

As I mentioned earlier, the stock market is volatile and there’s certain comfort in knowing your money is safe and earning a little bit of interest. While I’m not worried about my retirement savings, as my retirement is forty years away, I would be hesitant to put any money I’d need in the next five or ten years into the stock market right now simply because it spikes and craters so easily. Would you be surprised if the market jumped 700 points? I’d be a little happy but the reality is that it might drop 700 points the next day, with seemingly no rhyme or reason. CDs? They just go up… slow and steady, but I hear that wins races.

Lastly, the rate of return isn’t bad. 4.65% APY, which was the highest CD rate as of this writing, is pretty good. It probably beats your bank’s savings account rate. If you have an online bank account, the best high yield savings account rates are pretty good too so they’re worth checking out as well. All in all, 4.65% APY isn’t 10%, the typical number used to talk about the stock market but I think you’d be hard pressed to make that argument given our environment.

Three Bad Reasons

Despite their relatively high, and safe, returns, inflation will eat your lunch. Inflation is going at a pretty good clip these days, 4.9% as of September CPI numbers, and it is the biggest problem you run into when you save with CDs. If you save at 4.65%, you’re losing 0.25% of your purchasing power each year and that’s before taking taxes into account. If you’re in the 25% tax bracket, 4.65% APY is really 3.49% APY, which means you’re losing 1.41% of your purchasing power each year. That being said, the alternatives aren’t too spectacular either.

With CDs, you’re locked into a set period of time. The shortest CDs are usually 6 months and offer the least amount of interest. The sweet spot right now appears to be the 12 month and 18 month CDs, though if you’re willing to lock it in for 60 months (5 years), you would be handsomely rewarded (in today’s terms). Fortunately with CDs, you’re totally locked in. You can often liquidate a CD if you surrender a number of months interest (often it’s 3 months, but it varies). That’s a nasty pill to swallow if you need your money though.

Finally, there are some better options if you are willing to put your money in a little bit of risk. Tax exempt money market funds are a good place to store money and get a much better rate of return. I recently looked at the Vanguard Tax Exempt Money Market and it had a tax equivalent yield of around 6% APY. It invests in municipal bonds to earn that higher interest but it’s not FDIC insured.

There you have it, three good reasons why you should and three reasons why you shouldn’t save using CDs right now. If you have any thoughts on them, maybe a point I missed, please share them in the comments.

(Photo: corrieb)


 Investing 
7
comments

Tax Exempt Money Market Funds: VMSXX

When I compiled a list of high yield savings accounts rates, a reader mentioned that tax exempt money market funds blow all those returns out of the water. He was totally right. In fact, I have a portion of our savings invested (I say invested because your principal is not protected by FDIC insurance in a money market fund) in Vanguard’s Tax Exempt Money Market Fund (VMSXX [Google Finance: VMSXX]).

About Tax Exempt Money Market Funds

The Vanguard’s Tax Exempt Money Market, and in general all tax exempt money market funds, seeks to maintain the $1 share price while generating a return using very safe assets. Specifically, they invest in “short-term, high-quality municipal securities issued by state and local governments across the United States.” That’s how they can guarantee that the earnings are exempt from federal personal income tax. With VMSXX, they invest in securities that are a year or shorter and a dollar weighted average of 37 days (as of this writing). You’ll find that most funds are structured this way regardless of the company. I am using Vanguard as an example because I have my money there.

Calculate Taxable Equivalent Yields

Since the yield is exempt from taxes, it’s not fair to compare them to other investments without some additional math to account for the tax exempt status. The easiest way is to find out which marginal tax bracket you’re in and divide the yield by (1 – marginal tax bracket).

If I’m in the 25% tax bracket and I want to find the taxable equivalent yield of an asset with a yield of 4%, I divide 4.0 by 0.75 = 5.33%. A tax exempt security yielding 4.0% is the equivalent of a taxable security yielding 5.33%. That 25% tax really takes a big chunk out of that return, huh? That’s why tax exempt securities are so attractive.

You can use this simple tax equivalent yield calculator to help you do the math.

Not FDIC Insured, Other Points

Some things to keep in mind about money market funds:

  • They are not FDIC insured, so they are investments. However, I believe that tax exempt funds are safer because they are investing in munis; rather than corporate bonds. When those money market funds broke the buck a few weeks ago, it was because they were invested in Lehman corporate bonds. While those were considered safe too, a company is far different from a state or local government. That being said, state and local governments can also go bankrupt, it’s just less likely.
  • Much like savings accounts, these fund yields aren’t guaranteed. With an dollar averaged holding period of 37 days, the yields can fluctuate very rapidly and much more so than the yield on a savings account.
  • Don’t invest in tax exempt securities in tax-advantaged accounts like a Roth IRA. Since the earnings in a Roth IRA are already tax free, it makes no sense to put it in a tax exempt investment. You take the teeth out of what makes the investment attractive in the first place.

If you want to get another opinion, Nickel also put some money in VMSXX and wrote about his experiences with the tax exempt money market funds.


 Personal Finance 
28
comments

Emergency Fund Account: Money Market or High Yield Savings?

What is the most important thing about emergency funds? Capital preservation. Your emergency fund is supposed to be the foundation onto which the rest of your personal finance house is built upon and it’s not something that should be meddled with unnecessarily. You should pour it, let it sit, and hopefully never have to touch it. However, if you ever find yourself in a situation where you’ll need it, you want it to be there just as you had left it. That being said, a friend recently asked me if I ever thought about putting my emergency funds into a money market account or if a high yield savings account is better.

Money Market Deposit Accounts (MMDA)

For those who aren’t familiar with money market deposit accounts, they are basically savings accounts where the bank has greater discretion in terms of what it can invest in. In return for this greater flexibility, the banks often will give you higher interest rates but may demand that you give them at least 7 days notice before withdrawals (Federal Reserve Regulation D).

  • Principal is safe.
  • Interest rate is higher than regular savings.
  • Potential 7 day lag in accessing funds.

High Yield Savings Accounts

ING Direct, the high yield savings account that I believe has been around the longest, is offering 4.20% APY on their online savings accounts. Comparatively, Bank of America’s Balance Rewards Money market savings account’s highest APY is only 3.05% and that’s if you have over two and a half million dollars in your money market savings account. BoA’s money market account likely isn’t the highest around but it’s not even within spitting distance of ING’s 4.20% rate for nothing (and ING isn’t the highest rate around either!).

  • Principal is safe.
  • Interest rate is higher than regular savings.
  • 4-5 day lag in transferring funds from high yield savings to your bank

Money Market Mutual Funds

A money market deposit account may be confused with an actual money market mutual fund, which is a wholly different animal. A money market mutual fund is like any other mutual fund with its own risk and return profile. You might be offered a higher rate of return but in this particular case you have no guarantee on your principal. If things go south in whatever the fund invests in, like in any mutual fund, your emergency fund could find itself depleted. I would not invest my emergency fund in anything that doesn’t guarantee my principal.

However, let’s say you wanted to take the risk, what are the returns like? Vanguard’s Federal Money Market fund, just to take a random example, currently has a yield of 4.69% and an expense ratio of 0.24%. So, even if we ignore the expense ratio and look strictly at the yield, you’re talking 4.69% versus a 4.20% at 100% safe ING Direct. Half a percent isn’t worth it for me to open an account, transfer money, and take the risk.

  • Principal is not safe.
  • Interest rate is higher than regular savings.
  • Lag if you don’t have checkwriting rights.

Summary

Put part of your emergency fund in a high yield savings account, keep some reserve in a local bank so you can get to it ASAP. I don’t know why anyone would have any funds in a money market deposit account given current high yield interest rates. I also don’t know why anyone would put their emergency fund in a mutual fund, money market or otherwise, because of the risk, even if it’s low, you could lose your principal. We’re in a strange place now where high yield online savings accounts are giving such great returns and all these traditional products, like MMDA’s, are really not worth it anymore.

Where do you put your emergency savings and why?


 General, Personal Finance 
2
comments

Laddered CD/MMC Safe Investment Plan

Many people know that Certificates of Deposit (CDs) and Money Market Certificates (MMC) are one of the safest investment vehicles out there, but who wants to tie up their money all those years for the more attractive rates? The answer is no one. That’s why one of the “plans” that many financial advisers advocate is a laddered CD/MMC investment strategy where you purchase multiple certificates are different maturing dates so that you can lock in the best rates for your money. The net effect is after a few years, you own the best possible rates on your CDs that you could get.

Example:
You have $5,000 to invest. In the above plan, simply invest in the following:

  • $1,000 in a 1 Year MMC at 3.00% APY
  • $1,000 in a 2 Year MMC at 3.50% APY
  • $1,000 in a 4 Year MMC at 4.25% APY
  • $1,000 in a 5 Year MMC at 5.00% APY
  • $1,000 in a 7 Year MMC at 5.15% APY

(These values are from The Pentagon Federal Credit Union, or PenFed, which are probably the best rates out there, as of 2/17/05)

What happens is in a year, your 1 Year MMC matures, so you want to invest in another 7 Year MMC with that original investment to get the best rates. After another year, your 2 Year MMC matures and you invest in yet another 7 Year MMC. This continues and you keep locking in the best prevailing rate at the time for the safest investment. And these CDs are federally insured up to $100,000 by the National Credit Union Administration (NCUA), which is the Federal Deposit Insurance Corporation (FDIC) for credit unions.

Want to try it? PenFed’s minimum purchase requirement is a mere $1,000 per MMC and the eligibility requirements are actually pretty lax. Basically if you or a family member is a member of the armed services (Active, Guard/Reserve, or Retired), then you’re definitely eligible. They list other eligibility methods. If none of those fit, join the National Military Family Association which is a great organization that I am a member of and only costs $20 a year. If you happen to use Geico as an insurer, the NMFA is a member organization so if you mentioned to Geico that you are a member of NMFA, they will knock 7-8% (I forget which) off your bill.

The tradeoff you’ll have to consider is that if you put it in a completely liquid ING Direct account, you’ll get 2.35%. If you go with Emigrant Direct, you’ll be getting 3.0%, and that’s totally liquid which the MMC’s are not. Read this post on where to park short term funds for a discussion of ING Direct and Emigrant Direct.


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