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What’s in a Name?
Don’t assume that a “money-market” fund is a “money-market account.”
While banks offer money-market accounts, brokerage firms offer money-market funds. The two are not interchangeable, though you will often find them wrongly conflated on some financial do-it-yourself websites.
Money-market funds, often called “money funds,” are mutual funds, not savings accounts. They aim to maintain a constant one-dollar net asset value, or NAV, the price of the fund. Instead of paying interest, as do bank money-market accounts, funds generate a rate of return that is paid to the account in terms of additional, fractional shares. Money funds are also more liquid, meaning you can access the cash at any time, without any penalty and without any withdrawal limitations.
Though savers often assume a money-market fund is as safe as a money-market account, that’s not necessarily true. Yes, they are safe, relatively speaking. But while money funds are widely considered low-risk, because the NAV is not guaranteed you can lose money.
Indeed, during the mortgage-inspired financial meltdown in late summer 2008, the Primary Fund, one of the original money funds, “broke the buck,” the industry euphemism that colorfully describes what happens when the NAV sinks below one dollar. As the crisis gained momentum, the Primary Fund’s shares closed at one point at ninety-seven cents, a 3 percent loss. That’s not terribly large, of course, but when you’re investing for rock-solid safety any loss is just short of horrific.
Moreover, money funds carry no FDIC protection. So if you happen to be in a fund that breaks the buck, the FDIC doesn’t have to make your account whole.
Certificates of deposit, or CDs, generally earn even higher rates than money-market accounts, depending upon how long you’re willing to part with your money. The longer you agree to leave your money untouched, the larger the interest rate a bank is usually willing to pay. (On occasion, economic periods will arise in which longer-term interest rates are at or below short-term rates, what market pundits know as an inverted yield curve. In those moments, longer-term CDs will pay interest rates that are equal to and often less than shorter-term CDs.)
Interest rates on CDs can be markedly higher than those on savings and money-market accounts because of the amount of time you’re willing to let the bank put your money to work. Where a $10,000 money-market account was paying about 2.75 percent on average nationally in late 2008, a one-year CD was paying about 4 percent on average. Five-year CDs were paying more than 4.6 percent. With large balances, banks often sweeten the interest rate. At $100,000, what banks call a jumbo CD, rates for a one-year deposit were as high as 4.65 percent at some banks in late 2008. Five-year jumbos offered as much as 5.25 percent.
CDs are a fine place to stash cash, such as your emergency savings, that you do not expect to need for some period of time.
The higher interest rate means your money is working harder for you.
Like money-market accounts, CDs typically mandate a minimum investment to open the account, often $500 to $1,000. They are government insured, as well, in case of problems with your bank at some point.
The risk with a CD is that your money is supposedly locked away. You can withdraw it in an emergency, if necessary, but you will pay a price, usually forsaking three months of interest payments.
Laddering, the art of combining liquidity with income, is one of the savvier strategies with CDs. It’s a simple process of stretching over multiple maturity dates all the money you want to invest in CDs. In a basic example, you might put one-fifth of your money into five different CDs with annual maturity dates ranging between one and five years. The benefit here is twofold: you have access to some portion of your money every year, yet the bulk of it remains invested for the longer haul, earning greater returns. Each year, as a CD matures, if you don’t need the cash you just roll it over into another five-year CD (remember, all your other CDs will have one year less time remaining, so your original five-year investment is now down to four years, meaning you need another five-year CD to top off the ladder).
Laddering is a particularly useful strategy for times when interest-rate movements are uncertain. In those periods, guessing what rates might do exposes you to the risk of being wrong. You might keep all your money in short-term CDs expecting rates will soon rise, thereby allowing you to lock in a higher rate at some point. But if rates fall instead, you’ve lost that gamble, because when it’s time to roll over your current CD, you will earn a lower rate than previously. With a ladder, you will still earn that lower rate on the money rolled over, but you’ll also have those longer-term CDs locked in at higher rates for a while.
At times when rates are rising, you want to be in shorter-term CDs so that your maturity dates arrive fairly frequently, offering you the chance to roll into a higher rate. Conversely, in periods of falling interest rates, you generally want your money in longer-dated CDs that lock you into the highest possible rates, leaving your money unaffected even as interest rates slip.
What Is My Engine to Wealth?
Investing is the next step in wealth building after you’ve established your savings account. The aim of investing, at its core, is simple: to earn profits by putting your capital at risk.
In a savings account you’re taking no risk. The money you deposit is guaranteed by the government; it will always be there when you need it. The money you invest outside of savings is money you specifically want to put at risk in the hope of earning returns dramatically greater than you’ll ever earn on your savings. It may not be there when you need it, or the value of your original capital might be sharply reduced. With investing, the only guarantee is that there are no guarantees.
But no guarantee is no reason to avoid investing and, instead, stash all your money in savings and CDs. If nothing else, investing serves one very useful purpose: It helps your nest egg outpace the ravages of inflation.
Inflation: The tendency of prices to rise over time. Inflation is measured broadly by the federal government’s monthly Consumer Price Index, the CPI. Historically, inflation increased at an annualized rate of 3.3 percent between 1913, when U.S. Department of Labor statistics began, and late summer 2008.
Every year, for the most part, living your life grows increasingly more expensive. Interest rates on savings accounts, CDs, money-market accounts, and U.S. Treasury bonds”the safe investments”do not keep pace with inflation. Thus, your dollars in those accounts are actually losing value. That’s often a hard concept for people to grasp. After all, if you have $10,000 in a savings account this year, and next year you have $10,400 thanks to a 4 percent yield, you’d seem to be ahead of the game because you have more money today than you did yesterday.
But what if inflation was running at an annualized rate of 5.8 percent, as it was in the summer of 2008? The same amount of goods you could buy with your original $10,000 on the day you deposited the money would cost a year later $10,580. Your money actually lost $180 worth of purchasing power. You don’t see a physical loss of cash in your savings account, but your savings account has grown weaker in the course of a single year. Its ability to pay for your life has diminished.
Now, apply that across decades. You end up with a dollar that has no hope of paying your costs later in life unless you make it work harder than is possible in a savings account. That’s where investing takes over, and that’s why understanding the risks and rewards that define the various investment options is so crucial. Many people seek to avoid investments precisely because of the risk. But risk can be mitigated. And if you don’t take on some risk, then, as the inflation example above showed you, your standard of living is certain to fall victim to inflation over time.
Map of Komarno Port on social role the functional role played by an individual who holds a formal position in a social group, such as the role of squadron leader, teacher, or vice president of an organization. Positions of this kind are termed role categories, and the attitudes and behavior associated with each category are termed role expectations. social role theory a model contending that behavioral differences between men and women can be attributed to cultural standards and expectations about gender, rather than to biological factors. social schema a cognitive structure of organized information, or representations, about social norms and collective patterns of behavior within society. Whereas a selfschema involves a person’s conception of herself or himself as an individual and in terms of a particular personal role (or roles) in life, social schemata often underlie behavior of the person acting within group particularly large group, or societal contexts. social science any of a number of disciplines concerned with the social interactions of individuals, studied from a scientific and research perspective. These disciplines traditionally have included anthropology, economics, geography, history, linguistics, political science, psychiatry, psychology, and sociology, as well as associated areas of mathematics and biology. Map of Komarno Port 2016.
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