Even the most aggressive investors keep some of their money in capital preservation funds. Depending on your tolerance for risk, your personal circumstances, and your best guess for what the future holds, you might hold a little of your money or most of it in these funds.
These choices will not make you rich fast, but they're not going to make you poor overnight either. Because you can never perfectly predict the direction and timing of the stock market, it's always smart to have some access to cash.
- Keeping money that you might need soon in an FDIC-insured checking or savings account can protect it and give you quick access.
- Money-market accounts, CDs, and short-term Treasury bills are excellent places to keep the money you may not need for a few months.
- If you have money you don't need to access for a few years, corporate bonds, savings bonds, and municipal bonds that mature when you will need the money are excellent choices.
For Money You Need on Demand
This might sound like stuffing your cash in a mattress, but keeping a little cash on hand is critical for taking care of unexpected expenses. If you need money on short notice, meaning a few days or less, these are your two best options:
- FDIC-insured checking or savings account
- NCUA-insured checking or savings account
That's right—simple, straightforward checking and savings accounts. These choices get you local branch offices that you can walk into if you need to. Under ordinary market conditions, you also would be earning some interest income on your capital. Some savings accounts can yield as high as 1.5% or more.
The "FDIC-insured" part is critical. The Federal Deposit Insurance Corporation keeps your deposits of up to $250,000 fully insured by the federal government in case your banking institution defaults. Without this, a bank failure would mean that you'd lose your money. Meanwhile, checking and savings accounts at credit unions are also insured up to $250,000 by the National Credit Union Administration.
Alternatively, you could keep actual currency stuffed in an envelope or locked in a safe deposit box, but that includes the risk of loss or theft.
For Money You May Need in a Few Months
If you extend your window a bit longer, you get a few additional options for your capital preservation shopping list:
- Short-term United States Treasury bills maturing in 90 to 180 days held directly at the U.S. Treasury through a TreasuryDirect account
- FDIC-insured certificates of deposit maturing in 90 to 180 days
- FDIC-insured money market accounts (not to be confused with money market funds)
As with checking and savings accounts, the key factor is that your principal investment is backed by the guarantee of the U.S. government, either directly or through the FDIC. If another credit crisis like the one in 2008 hits, you want to emerge with your cash intact, even if your bank fails.
If you prefer to bank at a credit union, look for backing by the National Credit Union Association (NCUA), the credit union version of the FDIC.
FDIC insurance applies to the sum of all accounts of the same category you have with one institution, not $250,000 per account. For example, if you have a checking account and a savings account with the same bank, they would be insured for a total of $250,000 together. Accounts that are in different categories or held with different banks are each individually insured up to $250,000.
For Money You Need in a Few Years
If you don't need the money in the immediate future, your options get much broader as you can incorporate fixed-income securities into your potential asset mix.
Keep in mind that savings accounts and Treasury bills can also qualify for this longer-term category. For example, you can get FDIC-insured certificates of deposit that mature in five years, yielding a slightly higher interest rate while maintaining that safety guarantee.
Other options include:
- Corporate bonds maturing at the earliest date on which you may need your money
- Municipal bonds maturing at the earliest date on which you may need your money
- U.S. savings bonds (Series EE or Series I)
- U.S. agency bonds maturing at the earliest date on which you may need your money
You should generally avoid foreign bonds or foreign-currency-denominated instruments, as the U.S. government does not back these.
The greatest risks in this category will include interest-rate sensitivity, credit risk from the financial health of the bond issuer, and unexpected changes to when you might need the funds. If you choose a long-term for the bond, you risk losing potential profits if interest rates rise since you've locked in at a lower rate. If you choose a short term, you get less interest than is available at that moment in longer-term choices.
It's also a good idea to keep a close eye on expenses and taxes. If you are in the top tax bracket, for example, the tax-free status of most municipal bonds is likely to result in more net cash in your pocket than a higher-yielding corporate bond. It's important to break out a calculator and figure your taxable equivalent yield.