Where’s the Best Place to Park My Cash as the Fed Raises Rates?
For years when clients asked me where they should leave their cash (possibly for their Emergency Fund or upcoming expenses) the answer was always the same: Leave it wherever it’s the most convenient for you because with the Federal Reserve targeting a 0% Fed Funds rate no one will pay you for your cash.
But since March of this year the Fed has gone from a Fed Funds target of 0.00% to 0.25% to a target of 3.75% to 4.00%--and they are expected to raise rates even further before year end in order to tamp down sky-rocketing inflation.
So now where do you park your cash?
Below are the three main choices available to you, along with the pros and cons of each. I also included the current rate for each that I see on the Vanguard and Ally Bank websites.
Bank/credit union savings accounts (current=2.50%)
- Pros-very easy to access your money when you need it; should (see “Cons”) pay more as the Fed raises rates; deposits up to $250k are covered by FDIC insurance and therefore safe; the most liquid* option
- Cons-the interest rate paid is dependent on the whims of the bank/credit union and how badly they want your deposits
Bank CDs (current 1-year CD rate=4.80%)
- Pros-you’re locking into a set rate for a given period of time (this could be a “Con” if the Fed continues raising rates); deposits up to $250k are covered by FDIC insurance and therefore safe; since you’re buying an investment product directly there will be no fees paid to a “middleman”, like you see with money market funds; if you hold until maturity you’ll receive what you paid for the CD along with the interest the CD paid
- Cons-it’s a more involved process to purchase (you can find CD’s offered by many banks across the country at Bankrate.com or purchase CD’s through your brokerage account at Vanguard, Schwab, Fidelity, etc.); you’re locked into the investment until the CD matures and if you want the money before the maturity date you’ll have to pay a penalty; because you’re locked in to holding a CD until the maturity date it’s the least liquid option
Money market mutual funds (current rate=3.29%)
- Pros-it’s very easy to purchase; their rates move in lockstep with the Fed Funds target rate (albeit with a lag); they have a stable $1 share price so you can’t lose money; although they aren’t protected by FDIC insurance I would argue they’re just as “safe” as bank deposits
- Cons-if you need the money immediately there may be a 1-business day lag between the time that you sell it and the time you can access the cash; if rates start to go down you’ll eventually earn lower rates; there is an expense ratio associated with mutual funds which puts a damper on the rate you receive
*”Liquid” is a term used to describe how easily/quickly you can receive your money back. The most liquid vehicle would be bills from your wallet, but a close second would be a bank checking account that has a debit card.