In order to glean a better yield than my discount broker's bank account provided, I searched for and found higher-yielding savings accounts at smaller banks. So I decided to switch. It took a bit of time, especially for the transfer of the money between banks, but I thought it was worth it. I don't think so anymore.
In order to glean a higher yield than my discount broker's bank account provided, I struck out about three months ago to search for greener pastures. They were easy to find. Many smaller banks were offering FDIC-insured savings accounts (for balances up to $250,000) paying 1.50% or more if you applied online. So I decided to switch. It took a bit of time, especially for the transfer of the money between banks, but I thought it was worth it. I don’t think so anymore.
Keeping savings invested in a brokerage account has several potential advantages. First, I can still earn a respectable percentage return on the money. Second, the dollars are liquid and quickly accessible at my brokerage should I need to tap them (for example, to invest after a sudden, unexpected dive in the market).
In such a scenario, if my money were invested in a small bank savings account, I would have to transfer the funds to the brokerage accounts, taking valuable time that could prove a fatal flaw if stock prices recover so rapidly that I might miss the buying opportunity. Another alternative might be to open an account at the small bank’s brokerage arm, but that doesn’t suit me because I’ve found they generally charge higher fees than the big discount brokers and too often peddle self-serving products.
But there’s another important reason to shift from a traditional bank savings account to a brokerage investment account. Savings account yields remain anemic, and brokerages now are offering a number of investment vehicles that pay more than high-yield savings accounts (though, granted, the funds carry more risk). I refer to short-term and intermediate-term bond exchange traded funds (ETFs), many of which have expenses and turnover that are low.
Here I focus on two categories of bond ETFs: municipals and Treasury inflation protected securities, known as TIPS. The tax-advantaged funds should be held in taxable accounts for obvious reasons; the TIPS are taxed, so they are best held in tax-deferred or tax-free savings accounts.
Duration in Years*
Expense Ratio/Annual Turnover
SPDR Short-Term Municipal (SHM)
Yes, income tax and AMT free.
Less than 3
iShares S&P National AMT-Free Muni (MUB)
Yes, income tax and AMT free.
iShares Barclays TIPS Bond Fund (TIP)
PIMCO 1-5 Year US TIPS Index ETF (STPZ)
*Duration is a weighted average of the maturity of all income streams from a bond or portfolio of bonds.It’s especially important to note that the longer-duration bond yields are higher, though they carry more risk. When interest rates rise, the longer-term bonds are most affected. Long-term bond yields will rise to meet inflationary pressures but their intrinsic value will fall, diminishing the price you’ll receive when you sell.
A good example of how duration affects volatility is below. The longer-term municipal bond ETF (MUB), increases and decreases more than the shorter-term ETF (SHM) when inflationary expectations change. This means the short-term ETF is generally more stable, and more suitable, if less risk is desired.
Source: Yahoo! FinanceAlthough my approach -- to place available money in these short-term ETFs with some risk -- is right for me, it may not be for everyone. Municipal bonds can default. Therefore, the total return of the municipal funds depends not only on whether or not interest rates move one way or the other, but if bonds in the fund fail. If they default, or if interest rates rise, the fund would decrease in value.
Likewise, TIPs funds have some risk. For example, if we were to see deflation rather than inflation, these funds could potentially lose value. All of this is by way of saying that those who are truly risk-averse may want to stick with FDIC-insured savings accounts. It is better to sleep at night than worry about what your money is doing -- just as unsettling as not knowing what one’s children are up to.
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