Cash, meaning savings accounts, money market funds, and other cash-equivalent investments, have been yielding next to nothing since the beginning of the pandemic. Even before the pandemic, the federal funds rate† peaked around 2.40% in early 2019. If we go back even further, the federal funds rate was near zero from the beginning of 2009 through the end of 2015. For over a decade, except for a brief period a couple years ago, cash has been yielding essentially nothing. It may feel like the opportunity cost of keeping your emergency fund and other short-term savings in cash is enormous.
You’ve totally nailed your previous articles but I think there’s a significant hole in this one.
You say “There is no great alternative to cash that is just as safe and secure and pays a reasonable rate of interest.”
But what about i-Bonds? Because the purchase is from the US Government they are safe and secure. And, they certainly typically pay a (more than) reasonable rate of interest! It pays at least the inflation rate (set every 6 months) and can never earn below 0% even if we are in deflation. It is currently paying 3.54% (annually) guaranteed for the current six-month period.
Sure, because you can’t access the funds until 12 months later maybe someone decides they don’t want to use it for an emergency fund (though lots of people do and there’s ways to make this work if you plan well and frontload it or regularly buy them). But, if you can stomach the one year no access period, it’s fantastic for anything else short-term.
You define short-term as less than five years. Thus, i-Bonds would seem to be a perfect option for someone who is saving for a 2 to 5 certain purchase and would be much better than just leaving it in a savings account. Especially with inflation where it currently is and could go.
And yes if someone cashes out say two years later there is a withdrawal “penalty” for holding it less than five years but you only lose the last three months of interest which in reality is not that big of a deal. In this example if they were earning 3.54% over that 2-year time period it would be essentially as if they were still earning 3.1%. Pretty darn good if you ask me!
Great comment Brad! In the strange time we are in (where inflation is significantly higher than the federal funds rate/interest on cash), I bonds do look appealing. So if/when the Fed hikes rates, interest paid on savings accounts will be closer to the interest earned on I bonds (maybe 2-2.5% on cash and 3.5% on I bonds, like we had in the past when the funds rate was around that mark).
That's still a 1% spread, but is it worth it? The max amount you can put in I bonds is $10k/year. 1% on that is $100. The flexibility of cash may outweigh the $100 extra you could earn in interest; target dates for short-term goals can definitely change (think about how many people accelerating buying a home in the past year). Or it may not - if you know for sure when you'll need the money, getting that extra 1% may be worth it.
The unique times we are in, where I bonds are essentially paying 3% to 3.5% more than cash presents an opportunity, but thinking ahead to 2022, 2023, and beyond, the spread there may shrink. You are right that if you know when you'll need the money, and can sacrifice the liquidity of cash, there may be an opportunity in I bonds, especially now.
Good clarifications there and the idea that we may be in a unique time today and in the recent past.
Just something else to note: technically you can do $15k per year if you use the additional 5k from a tax refund as a paper iBond. And the $15k limit is per SSN so technically a married couple could do up to $30k per year.
Great article. I needed this one. I kept saying to myself why do I keep building up my liquid cash if it is not making any money. Thanks
Hey Daniel,
You’ve totally nailed your previous articles but I think there’s a significant hole in this one.
You say “There is no great alternative to cash that is just as safe and secure and pays a reasonable rate of interest.”
But what about i-Bonds? Because the purchase is from the US Government they are safe and secure. And, they certainly typically pay a (more than) reasonable rate of interest! It pays at least the inflation rate (set every 6 months) and can never earn below 0% even if we are in deflation. It is currently paying 3.54% (annually) guaranteed for the current six-month period.
Sure, because you can’t access the funds until 12 months later maybe someone decides they don’t want to use it for an emergency fund (though lots of people do and there’s ways to make this work if you plan well and frontload it or regularly buy them). But, if you can stomach the one year no access period, it’s fantastic for anything else short-term.
You define short-term as less than five years. Thus, i-Bonds would seem to be a perfect option for someone who is saving for a 2 to 5 certain purchase and would be much better than just leaving it in a savings account. Especially with inflation where it currently is and could go.
And yes if someone cashes out say two years later there is a withdrawal “penalty” for holding it less than five years but you only lose the last three months of interest which in reality is not that big of a deal. In this example if they were earning 3.54% over that 2-year time period it would be essentially as if they were still earning 3.1%. Pretty darn good if you ask me!
People can see more about i-Bonds and the rate of return history here: https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm
Thoughts?
Great comment Brad! In the strange time we are in (where inflation is significantly higher than the federal funds rate/interest on cash), I bonds do look appealing. So if/when the Fed hikes rates, interest paid on savings accounts will be closer to the interest earned on I bonds (maybe 2-2.5% on cash and 3.5% on I bonds, like we had in the past when the funds rate was around that mark).
That's still a 1% spread, but is it worth it? The max amount you can put in I bonds is $10k/year. 1% on that is $100. The flexibility of cash may outweigh the $100 extra you could earn in interest; target dates for short-term goals can definitely change (think about how many people accelerating buying a home in the past year). Or it may not - if you know for sure when you'll need the money, getting that extra 1% may be worth it.
The unique times we are in, where I bonds are essentially paying 3% to 3.5% more than cash presents an opportunity, but thinking ahead to 2022, 2023, and beyond, the spread there may shrink. You are right that if you know when you'll need the money, and can sacrifice the liquidity of cash, there may be an opportunity in I bonds, especially now.
Good clarifications there and the idea that we may be in a unique time today and in the recent past.
Just something else to note: technically you can do $15k per year if you use the additional 5k from a tax refund as a paper iBond. And the $15k limit is per SSN so technically a married couple could do up to $30k per year.
Or maybe $25k, not sure if married jointly works for both or not.