Managing Cash When Interest Rates Are Low

The economy may be improving, but high unemployment and low inflation indicate that the Federal Reserve may keep interest rates low at least until 2012.¹

It’s generally a good idea to keep three to six months of income in an emergency fund to help cover unexpected expenses or a sudden loss of income. But when interest rates are low, where should you keep your cash?

Savings Accounts

Perhaps the most appealing aspect of savings accounts is that they are insured and highly liquid. The Federal Deposit Insurance Corporation insures deposits up to $250,000 per depositor, per institution, in principal and interest. You can generally withdraw your money at any time, although you could be subject to a fee if you exceed the financial institution’s monthly limit on withdrawals or transfers.

One disadvantage is that savings accounts may offer lower interest rates compared with other cash alternatives. Although you are unlikely to lose money deposited in a savings account, you could lose purchasing power over the long run if the interest rate does not keep pace with inflation.

Certificates of Deposit

CDs may offer slightly higher interest rates than savings accounts, but you generally must commit your principal for a period of months or years. Early-withdrawal penalties vary by institution and may range from several days’ worth of interest to the loss of some principal.

Typically, the interest rate paid by a CD depends on the maturity date. The longer you are willing to commit your money, the higher the interest rate you may be able to earn. Some CDs also offer higher rates for larger deposits. However, if your principal is locked into a CD when interest rates increase, you may not be able to take advantage of the higher rates until your CD matures, and the early-withdrawal penalty may offset any gains from reinvesting at a higher rate. The FDIC also insures CDs (up to $250,000 per depositor, per institution), which generally provide a fixed rate of return.

Money Market Funds

Money market funds are mutual funds that invest in short-term debt. These funds typically pay dividends, which may be greater than the interest paid by a savings account or CD. Generally, there are no limits or penalties for redeeming shares from a money market fund.

Money market funds are neither insured nor guaranteed by the FDIC or any other government agency. Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in such a fund.

Mutual funds are sold only by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

1) MoneyRates.com, 2011

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2011 Emerald Connect, Inc.