Safety is the name of the game when it comes to your savings. The last thing you want when trying to build a savings cushion is to lose it all and return to square one.
Fortunately, you can stash savings in a number of safe financial instruments that also reward your efforts with a little free money in the form of interest.
While they aren't going to set the world on fire with sky-high returns, the following investments each provide a safe place to park your savings:
1. Checking accounts
- What they are: Interest-bearing checking accounts allow account holders to access funds with checks and debit cards while still earning interest on their money.
- Risk: These accounts are insured for up to $250,000 by the Federal Deposit Insurance Corp. or the National Credit Union Administration (for credit unions) through Dec. 31, 2013. On Jan. 1, 2014, the standard insurance amount is scheduled to return to $100,000.
- Liquidity: Interest checking accounts are extremely liquid. Most come with the ability to write checks, transfer cash and make debit purchases. For many accounts, however, account holders are assessed a fee if the balance drops below a certain minimum.
- Pros and cons: Interest-bearing checking provides the opportunity to earn interest with high liquidity and low risk. However, most interest checking accounts charge higher fees than their "free checking" counterparts. In many accounts, these fees can be waived if the accountholder meets certain conditions -- for example, keeping a minimum balance or making at least five debit card transactions in a month.
Regular interest-bearing checking accounts also typically pay interest well below the rate of inflation, so money that's left in these accounts runs the risk of losing significant purchasing power over time.
High-interest checking accounts reward savers with an above-average rate of return. However, many of these accounts brim with fees and requirements that threaten to erode any possible benefits. So, it's important to review terms and fee schedules before choosing an account.
- Where to find them: Banks, credit unions and other institutions offer checking accounts. Bankrate can help you find the best checking rates currently available.
2. Savings accounts
- What they are: Savings accounts are basic interest-paying deposit accounts.
- Risk: Savings accounts are insured by the Federal Deposit Insurance Corp. or the National Credit Union Administration (for credit unions), meaning they can't lose principal on account balances of $250,000 or less through Dec. 31, 2013. On Jan. 1, 2014, the standard insurance amount is scheduled to return to $100,000.
- Liquidity: High liquidity is the principal advantage savings accounts have over certificates of deposit. Under the Federal Reserve's Regulation D, account holders may make up to six withdrawals or transfers from a savings account each month. Banks may impose fees for exceeding an arbitrary limit for withdrawals, or for failing to meet a minimum account balance in a given month. However, savings accounts remain one of the most liquid interest-bearing vehicles.
- Pros and cons: On the plus side, savings accounts offer high liquidity at low risk.
As with other deposit products, the main risk for holders of savings accounts is that their money will diminish in purchasing power as inflation takes its toll. This is especially true of traditional passbook savings accounts, which often sport a yield that falls far short of other savings vehicles, such as CDs.
Higher yields sometimes can be found online or in high-interest savings products offered by credit unions and larger banks. Still, unlike CDs, yield on savings accounts can change quickly and without notice.
- Where to find them: Banks, credit unions and other institutions offer savings accounts. Bankrate can help you find the best savings rates currently available.
3. Certificates of deposit
- What they are: Certificates of deposit, or CDs, are federally insured time deposits with specific maturity dates that may range from several weeks to several years. The financial institution pays you interest at regular intervals. Once the CD matures, you get your original principal back plus any accrued interest. There are several different types of CDs, including jumbo, callable and flexible.
- Risk: CDs are considered safe investments. Most are insured by either the Federal Deposit Insurance Corp. or the National Credit Union Administration (for credit unions), meaning they can't lose principal on account balances of $250,000 or less through Dec. 31, 2013. On Jan. 1, 2014, the standard insurance amount is scheduled to return to $100,000.
- Liquidity: CDs aren't as liquid as savings accounts or money market accounts because you tie up your money until the CD reaches maturity -- often for months or years. It's possible to get at your money sooner, but generally you'll pay a penalty.
- Pros and cons: CDs provide interest income with relatively low risk. However, if you try to cash out your CD prior to maturity, you may incur a penalty, such as the loss of interest for a quarter. Federal law requires a minimum penalty of at least seven days' simple interest on amounts withdrawn within the first six days after deposit. The law doesn't set a maximum penalty, so banks can charge as much as they want. Another downside: Earned interest is subject to income tax.
CDs also carry reinvestment risk -- the risk that when interest rates fall, investors will earn less when they reinvest principal and interest in new CDs with lower rates. Another risk occurs when interest rates rise. For example, people who lock into an interest rate over several years may regret their decision if rates on newly issued CDs suddenly rise.
Consider laddering CDs -- investing money in CDs of varying lengths and terms -- so that all your money isn't tied up in one instrument for a long time. Learn more about CD laddering in Bankrate's Investing Basics.
CD returns often are higher than those of traditional savings accounts. Still, inflation and taxes easily can significantly erode the purchasing power of money invested in CDs.
- Where to find them: You can purchase CDs at banks, credit unions and brokerage firms. Bankrate can help you find the best CD rates currently available.
4. Money market accounts
- What they are: A money market account, or MMA, is an interest-bearing deposit account. This type of account should not be confused with money market funds, which are mutual funds that normally are not insured. MMAs typically earn higher interest than savings accounts and require higher minimum balances. In exchange for better interest earnings, consumers usually have to accept more restrictions on withdrawals, such as limits on how often you can access your money.
- Risk: Most money market accounts are insured by the Federal Deposit Insurance Corp. or the National Credit Union Administration (for credit unions), meaning they can't lose principal on account balances of $250,000 or less through Dec. 31, 2013. On Jan. 1, 2014, the standard insurance amount is scheduled to return to $100,000.
However, you could lose some or all of your principal if your account is among the few not insured.
- Liquidity: Federal regulations limit withdrawals to six per month (or statement cycle), of which no more than three can be check transactions.
- Pros and cons: MMAs are safe investments that often allow limited check-writing privileges. However, it's important for investors to shop around because interest rates vary. Withdrawals are limited to a certain number each month, and fees can add up quickly if you don't maintain a certain minimum balance. Earned interest is subject to income tax.
If inflation rates exceed the interest rate earned on the account, your purchasing power could be diminished.
- Where to find them: Banks and credit unions offer MMAs. Bankrate can help you find the best money market rates currently available.
5. Money market funds
- What they are: Money market funds are mutual funds that typically invest in high-quality, short-term investments that mature in 13 months or less. Fund investments can include U.S. Treasury securities, CDs, federal agency notes, commercial paper and municipal securities. Money market mutual funds base their annual rate of return on the yield the fund has earned over a seven-day period. Fund managers try to maintain a share price of $1. The share price is known as net asset value, or NAV.
- Risk: Because money market funds technically are securities, they are not insured by the Federal Deposit Insurance Corp. or the National Credit Union Administration (for credit unions). So there's no guarantee that the share price will remain stable at $1 per share. If the share price dips below $1, you could lose some of your principal. When a money market fund is unable to maintain a $1 NAV, it's known as "breaking the buck." This rarely happens, although it has occurred occasionally in recent years as a consequence of the credit crisis.
- Liquidity: Money market funds, like money market accounts, often provide check-writing and money transfer privileges for shareholders.
- Pros and cons: Money market funds, like other mutual funds, can be bought or sold at any time. They typically pay investors a monthly dividend.
Yields usually are competitive with savings accounts. The U.S. Securities and Exchange Commission prohibits the average maturity of fund investments from exceeding 90 days. Restricting investments to such short terms helps reduce risk to investors by protecting them from major rate fluctuations that may occur over longer periods. Interest rates can vary, so there's no guarantee of how much you'll earn from month to month.
Money market funds usually provide lower returns than riskier investments such as stocks, which means inflation and fees can eat away at returns over the long run. Also, earned interest may be subject to income tax depending on whether the fund invests in taxable or tax-exempt securities.
- Where to find them: You can buy money market funds at brokerage houses, mutual fund companies and some banks.
6. U.S. Treasury securities
- What they are: U.S. Treasury securities include bills, notes, bonds, U.S. savings bonds and Treasury inflation-protected securities.
Treasury bills, or T-bills, are short-term debt instruments the U.S. government issues to raise money to pay for projects and pay its debts. Maturities of T-bills range from a few days to 52 weeks. Technically, T-bills are not interest-bearing. Instead, they are sold at a discount from their face value, and the government pays you full face value when the bills mature. For example, if you buy a $1,000 T-bill for $980, you would earn $20 on your investment.
Treasury notes, or T-notes, are issued in terms of two, three, five, seven and 10 years and pay interest every six months until they mature. The price of a note may be greater than, less than or equal to the face value of the note, depending on demand. If demand by investors is high, the notes will trade at a premium, which effectively reduces investor return. Upon maturity, investors are paid face value.
Treasury bonds are issued with 30-year maturities and pay interest every six months. They are sold at auction four times a year: in February, May, August and November. The price and yield are determined at auction. Upon maturity, you are paid face value plus interest.
U.S. savings bonds come in two different varieties: Series EE savings bonds and Series I savings bonds. Both can be redeemed after a minimum of one year, but redeeming them after less than five years results in forfeiting three months' worth of interest. The primary difference between the two types is that Series EE savings bonds have a rate that's completely fixed, while Series I bonds have a variable-rate component indexed to inflation. Savings bonds are accrual-type securities, meaning the interest is added to the bond monthly and is paid when the bond is cashed.
Treasury inflation-protected securities -- more commonly known as TIPS -- have a principal component that is guaranteed to increase with inflation and decrease with deflation as measured by the Consumer Price Index. TIPS also pay interest twice yearly at a fixed rate. This amount is applied to the adjusted principal and also rises and falls with the inflation rate. When a TIPS reaches maturity, the investor receives either the original principal or the adjusted principal, whichever is greater.
Bills, notes, bonds and TIPS are offered in increments of $100. U.S. savings bonds can be purchased for as little as $25 electronically or $50 if purchased in person at a bank or other financial institution.
- Risk: Treasury securities are considered virtually risk-free because they are backed by the full faith and credit of the U.S. government. You can count on getting interest and principal back at maturity.
- Liquidity: All Treasury securities are liquid, but if you sell prior to maturity you may experience gains or losses depending on the interest rate environment (see risks, above).
- Pros and cons: Treasury securities are considered an affordable, safe investment for the average investor. The value of securities fluctuates depending on whether interest rates are up or down. In a rising rate environment, existing bonds lose their allure because investors can get a higher return from newly issued bonds. Therefore, if you try to sell your bond before maturity, you may experience a capital loss.
Low return on your investment -- in exchange for lower risk -- is the main downside to Treasuries. Many Treasuries also are subject to inflation pressures. If the interest rate of the security is not as high as inflation, investors lose purchasing power. Because they mature quickly, the risk of holding T-bills is not as great as with the longer-term T-notes or T-bonds.
Some Treasuries offer measures of protection against inflation. Series EE bonds are guaranteed to double in value after 20 years, regardless of the interest rate you initially buy them at. Series I bonds are partially indexed to inflation. Treasury inflation-protected securities are guaranteed to keep pace with inflation; however, they also may decline in value in periods of deflation.
Interest income from all five types of Treasuries is subject to federal income tax but exempt from local and state income taxes.
- Where to find them: Treasury securities can be bought and sold via the TreasuryDirect program or through a broker or financial institution.
7. Government bond funds
- What they are: Government bond funds are mutual funds that invest in debt securities that the U.S. government and its agencies issue. The funds invest in debt instruments such as T-bills, T-notes, T-bonds, Treasury inflation-protected securities and mortgage-backed securities issued by government-sponsored enterprises such as Fannie Mae and Freddie Mac.
- Risk: Funds that invest in government debt instruments are considered to be among the safest investments because the securities are backed by the full faith and credit of the U.S. government.
- Liquidity: Bond fund shares are highly liquid.
- Pros and cons: Government bond funds are considered low-risk investments that can provide diversification to investment portfolios. They tend to pay higher dividends than money market and savings accounts and typically pay out dividends more frequently than individual bonds, sometimes monthly. Moreover, certain government bond funds are exempt from state and local taxes.
However, like other mutual funds, the fund itself is subject to risks -- namely interest rate fluctuations and inflation. If interest rates rise, bond prices decline, and if interest rates decline, bond prices rise. Interest-rate risk is greater for long-term bonds. Furthermore, if the inflation rate rises, purchasing power can be diminished.
- Where to find them: Shares held in bond funds can be bought and sold through a mutual fund company or brokerage firm.