Where to Stash Your Cash

There are better places to put your emergency fund cash than under the mattress. When looking at where to keep emergency funds there are two key features to keep in mind: the funds need to be safe during bad economic times and easily convert into cash. As a consequence one shouldn’t expect to earn high rates of return. Safety has its cost.

FDIC Insured Checking and Savings Accounts
This is where I hold my emergency funds and I would suspect that it is the primary choice for most people. The Federal Deposit Insurance Corporation (FDIC) insures deposits in checking and savings accounts up to $250,000. The insurance is per depositor per institution. If you have multiple accounts at a single bank the sum of those accounts is insured to the $250,000 limit. The interest earned in these accounts is small compared to other options and taxed as regular income. Again, these funds are not meant to earn big returns, they’re meant to be accessible in an emergency.
FDIC Deposit Insurance

Money Market Deposit Accounts
Money Market Deposit Accounts (MMDAs) were first introduced in 1982 and are now widely available from banks and credit unions. These accounts are backed/invested in safer securities such as Treasury Bills, certificates of deposit and other commercial paper securities. As a consequence the interest received on these accounts varies with the returns generated from the underlying investments, which can be higher than a traditional checking account. They also enjoy the same FDIC insurance as checking and savings accounts, but typically require maintaining a higher account minimum compared to a straight savings account. Interest is taxable as regular income at both the Federal and state levels. MMDAs may also offer some limited check writing capability which is currently restricted to 6 transfers/withdrawals per month by the Federal Reserve (see Federal Reserve Board Regulation D).

Certificates of Deposit (CDs)
Certificates of Deposit are issued by banks and sometimes referred to as “time deposits” as the funds are essentially locked up until the CD reaches it’s maturity date. The funds can usually be withdrawn prior to this date, but will incur a penalty for doing so. The benefit of locking money away in this fashion is that it usually earns a higher rate of return compared to traditional checking and savings accounts. CDs also benefit from being insured by the FDIC. The interest is taxable as regular income.
ABCs of CDs from SEC.gov

Series EE Bonds
Series EE bonds are issued electronically through Treasury Direct in any amount between $25 and $10,000. Interest is added to the bond every month and compounded every 6 months for up to 30 years. They cannot be redeemed in the first year of ownership and are subject to a penalty if redeemed in the first 5 years of ownership (the previous 3 months of interest are not paid). Interest is subject to Federal income taxes but is exempt from state and local taxes. An additional benefit of EE bonds is that they are exempt from Federal taxes when used to pay for qualifying educational expenses.
Series EE Savings Bonds at TreasuryDirect.gov

I Bonds
I Bonds are similar to Series EE Bonds in all of the previously mentioned ways including tax status and redemption policies. However, they are different in the way that interest is calculated and paid. The interest rate on an I Bond has two parts: a fixed rate and an additional rate that is indexed to inflation. Thus as inflation rises the bond will pay out higher interest payments. This makes I Bonds more attractive for long-term savings as it will preserve some level of purchasing power.
I Savings Bonds at TreasuryDirect.gov

Treasury Bills
In extremely rare instances where individuals exceed the $250,000 FDIC limits there are not many options available to safely store cash. The best option is usually loans issued by the United States through the Treasury Department (Treasuries for short). Treasuries are backed by the full faith and credit of the United States, which has never defaulted on it’s debt obligations*. As such they are considered to be among the safest financial assets in the world. Broadly speaking Treasuries can be purchased with maturities ranging from 4 weeks to 30 years. Those with a maturity of 52 weeks or less are referred to as Treasury Bills and can be purchased through Treasury Direct in multiples of $100 with maturities of 4, 13, 26 and 52 weeks. They pay no interest, but instead are purchased at a discount to face value. The interest received is the difference between the amount paid and the amount received at maturity. Interest is taxable as ordinary income at the Federal and state levels. The minimum holding period is 45 days before it can be sold on the secondary market. The secondary market is one of the major benefits of Treasuries as it is one of the largest and most liquid financial markets in the world. According to the Securities Industry and Financial Markets Association (SIFMA) there was over $1.5 trillion in Treasury Bills outstanding as of December 2015. Funds such as the Vanguard Short-Term Treasury Fund (VFISX) are one way to access Treasury Bills. However, the interest received from bills is fairly small and as a result any fees or expenses can quickly take a cut out of your return. The best way to own these in my opinion is to purchase them directly from the Treasury. The 4, 13 and 26 week maturities are auctioned weekly and non-competitive bids can go up to $5 million. The 52 week maturity is currently auctioned once a month.
Treasury Bills at TreasuryDirect.gov

Short-Term Municipal Bonds
Municipal bonds can be very attractive to those in higher income tax brackets as the interest earned is exempt from Federal taxes (and state taxes in certain states). Municipal bonds are issued by states and local governments and can be purchased individually or collectively through a mutual fund or ETF. I personally don’t wish to spend huge amounts of time investigating the financial condition and credit worthiness of the governments and local agencies that issue these bonds. I find it far easier to diversify any exposure to municipal bonds through a low cost mutual fund. The Vanguard tax-exempt bond funds such as the short-term fund, VWSTX, are among the best options out there right now. The short-term fund features an average maturity of 1.6 years and an expense ratio of 0.20%. Additionally there are also some state specific municipal bond funds catering to residents of states with high income tax rates (i.e. New York and California).

*The United States temporarily defaulted on some Treasury Bill issues in April and May of 1979. Eventually Treasury did pay these obligations: http://www.forbes.com/sites/beltway/2013/10/08/actually-the-united-states-has-defaulted-before/

What I’m Reading
Millennials Are Outpacing Everyone in Retirement Savings (Time)
How Much Are Your Social Security Benefits Worth? (About Money)
You Can’t Trust What You Read About Nutrition (FiveThirtyEight)
We don’t know what to eat (Washington Post)
The True Story of the Gender Pay Gap (Freakonomics)
Daniel Kahneman in Conversation with Michael Mauboussin (Farnam Street)