I know I start all of my articles this way, but in the past, in this article specifically, I discussed what interest was and how it increases your out-of-pocket costs when you take out a loan. In short, I talked about how interest was harmful to you. However, this is an untrue generalization, as in a number of instances, interest can actually be beneficial, instances that you will/already do experience in everyday life.
To begin, it's important to note that interest is simply a regular payment made at a predetermined percentage rate. When it comes to finance, interest is paid when money is being loaned or borrowed. If you are borrowing money, you pay interest to the lender. If you are lending money, you receive interest from the borrower. I explain why interest exists in this article. This clarification is important; interest is simply a periodic payment, it is only bad or good when additional context is provided.
With that said, you're probably wondering what situations allow the average person, like me and you, to earn interest rather than pay it. No, it's not loaning money to friends or family, but you're on the right track.
It's in the same general area, loaning out money, but in the opposite context of what we’re used to; no, you're not providing loans to people, instead, you're loaning your money to institutions. This means you're lending money to (yes, lending to, not borrowing from) banks, credit unions, and other similar financial groups. How is this possible? Well, there are a few key ways.
Before I begin, let me clarify that this article will be focused on guaranteed interest, not “interest”/returns from investments.
The first way of getting your money to work for you is your vanilla savings account. This might be the most obvious and boring option, but it is an option nevertheless. The majority of savings accounts guarantee some interest, however it tends to be very low. An alternative to regular savings accounts are high yield savings accounts (HYSA), which behave like regular savings accounts, but tend to offer significantly higher interest rates. Not every bank will offer an HYSA, so make sure to check if yours does. In both of these cases, you deposit your money into a savings account, the bank lends it out and pays you interest. Again, it may not be that much (usually under 1%), but it adds up over time and is infinitely better than keeping your money in cash.
Another way of earning interest on your cash is placing your money in certificates of deposit (CDs) and money market accounts. Both of these accounts provide much higher interest than your normal savings account, again ranging from 0.3% and going up to 0.8% per year. However, because these accounts offer higher interest rates, they also come with a couple restrictions.
The first is that you must maintain a minimum balance (in money market accounts) or deposit a minimum amount (certificates of deposit). If you don’t maintain this minimum, you will be charged a penalty until you can raise your balance. In the case of CDs, you simply cannot open an account unless you have the minimum.
CDs also require you to keep your money in the account for a certain amount of time, ranging from 3 months to 5 years. The longer your money stays “locked up”, the more interest you get. Money market accounts don’t have this kind of restriction, however, they do restrict your withdrawals, so you can only withdraw from a money market account a few times every year. Read more about certificates of deposit here.
The third method of earning interest using your cash enters investing territory but is still significantly less volatile than most investments. You may have guessed it, I’m talking about bonds. Bonds are offered by both companies and by the US government (and in many cases, local governments). When you purchase a bond, you loan money to the institution (company/government), they promise to pay you back the entire loan amount (called the principal amount) after a certain number of years (called the term of the loan) and agree to pay you interest until they pay back the loan.
While most major bonds variations do fluctuate in price, they tend to fluctuate a lot less than stocks. However, in many cases, you are required to hold your bonds for a certain amount of time, so if you think you’ll need access to your money in the near future, a savings account is probably best for you.
This leads us to my disclaimer segment. Deciding where you should keep your cash is heavily dependent on your situation. First of all, make sure you have an emergency savings account with 3-12 months worth of living expenses stored aside in cash. This should be kept in a normal savings account, and shouldn’t be “locked up”, so avoid certificates of deposit and bonds.
If you plan on needing your cash in the near future (under 2-3 years), a savings account is probably best, but if you're willing to keep your money away and untouched for a while (3+ years), consider bonds or longer-term certificates of deposit.
As always, I am not a financial advisor, none of this is financial advice, and make sure to consult a registered financial professional before making any financial decisions.
With all that said, I encourage you to look into any of the methods I talked about today as a way of storing your cash and put your money to work. Keeping cash is always important, and keeping it in an interest-earning vessel can be very helpful.
I hope you enjoyed this week's article, thanks for reading, and I’ll catch you in the next one!