Ask Money

Where to save?

Chris Farrell Dec 7, 2009

Question: Hi Chris, I’m a long-time listener to your Marketplace Money segments. You’ve got a talent for answering complex questions in a simple and straightforward way. Thank you! My question: what options exist besides a savings account for a short-term, stable investment that needs to be accessed on a schedule irrespective of market conditions?

I’ve decided to attend business school full-time, starting in Aug. 2011. I am excited! But there remains the problem of actually paying for the program. Some of it will be financed of course, but I would like to save up as much cash as I can over the next 18 months to minimize that debt. What’s more, if I fail to save at least a certain amount I will be denied entry to the program as I’m attending on a student visa and need to prove I have enough to cover living expenses.

So over the next 18 months I will be saving up as much cash and liquid investments as I can. And the key is I need to cash out entirely on or before Jul ’11, regardless of current market conditions, so stability is very important.

Obviously a savings account would be a safe option. But I am willing to take a little bit of risk, as every extra dollar saved now will pay out later by reducing my future debt. However with everything that has happened since 2008, I am concerned about taking on too much risk and wiping out my fund entirely. So beside a savings account, what options would you suggest that I consider? Mark, Mountain View, CA

Answer: Thanks for listening all these years. That’s great. The money problem you face is commonplace these days. So many people confront a big bill or bills in the near-term, such as tuition. They’d love to get more than 0.1% on their savings before writing the checks. But they’ve learned over the past several years to take downside risk seriously.

I would stay conservative. You don’t have much time. And your making a good investment in graduate school.

What are some alternatives to a savings account (and I would look into online savings accounts since they typically pay a higher rate)? My favorite idea is to buy short-term Treasury bills from the federal government at www.treasurydirect.gov. You won’t pay any commissions. There is no credit risk with Treasuries. Since you live in a high income tax state, you’ll the added benefit that there no state and local government levy on U.S. Treasuries. The historic record shows that short-term Treasuries will protect your money against the risk of inflation. (As an aside, my favorite number of the day: Gold peaked at $850 an ounce in January 1980. Investors who bought back then have a 44% gain with gold reaching a record $1,226.56 on Dec. 3. Yet according to Bloomberg, over the same time period the Standard & Poor’s 500 stock index produced a 22-fold return, Treasuries rose 11-fold and cash in the average U.S. checking account was up at least 92%. )

Like a lot of market-watchers, I expect the Federal Reserve will start hiking its benchmark interest rate once it’s clearer that the recovery is gaining momentum. The shift in monetary policy will show up immediately in higher Treasury bill yields. When the bills you’ve bought come due you can roll them over into higher yielding Treasury bills.

You could also be opportunistic with short-term CDs. For instance, Bankrate.com keeps track of rates around the country. You can check on what local institutions are offering customers, too. I would just make sure that you come out ahead compared to Treasury bills after taking taxes into account. (You’ll pay federal, state and local taxes on CDs.)

Over the past year investors have embraced fixed income investment. The year-to-date returns on all kinds of bond mutual funds are strong. You could put a sliver of money into a low-fee short-term government bond fund or a short-term well-diversified bond index fund. My concern here is timing. What if the Fed starts aggressively hiking rates around the time you want the money and the value of the mutual fund falls just when you need to cash it in? It’s a risk.

Good luck with graduate school. And does any one else have a suggestions?

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