Planning a big purchase in a year or two? Had a big windfall recently and want to sock it away for a little while? Many of us, at some point, find ourselves with a need for a financial "parking spot" -- a place to park some money for a relatively short period, where we can earn some interest to stay ahead of inflation with minimal risk of loss. Here's a quick survey of the leading parking-spot options, with some thoughts on the pros and cons of each.
High-yield bank accounts
Yes, boring old bank accounts can make a good parking lot in some cases. Most banks and credit unions offer a "money market" or other kind of special high-interest savings account. These accounts generally have higher minimum-balance requirements than regular savings accounts -- and they may come with higher fees, too -- but they aim to offer rates that are competitive with other short-term investments like money market mutual funds. To find the highest rates available to you, check out Bankrate.com as well as local small banks and credit unions, since smaller institutions often pay higher rates than the bigger players, like Bank of America
- Minimum investment: Can be as low as $1, but rates often go up as your deposit size increases and may not be competitive until your balance exceeds $25,000 or more.
- Pros: Rates can be surprisingly good -- several banks currently offer rates around 5%. Your deposit is accessible at any time, with no penalty.
- Cons: You'll often be able to get higher interest rates elsewhere, so shop around.
- Risk: Essentially none up to $100,000, the limit on FDIC insurance. Beyond that, your risk is still extremely low, as long as your bank stays in business.
- Upshot: If liquidity is important to you, you might be pleasantly surprised by the rates available. Don't forget to check with your local credit unions!
Money market mutual funds
Flexible and secure, money market mutual funds constitute a favorite parking place for many Fools. The ease with which funds can be transferred into and out of longer-term investments, plus the low fees, the availability of bank-like features such as check writing, and the availability of tax-advantaged options, all make these products widely appealing.
- Minimum investment: Varies, but usually no more than $2,500.
- Pros: Good yields, liquidity, ease of transfer to other investments, available tax-advantaged options.
- Cons: Not FDIC-insured. In some cases, you may have to wait several days after making a redemption before you have cash in hand.
- Risk: Very low, but not zero. There's no FDIC guarantee.
- Upshot: A strong contender, particularly if you already have an account with a leading fund provider such as Vanguard or Fidelity. Check out fellow Fool Dan Caplinger's excellent review of money market basics to learn more.
Certificates of deposit (CDs)
As Dan also pointed out recently, CDs aren't just for Grandma anymore. The combination of solid yields with low risk is a strong one for those who won't need access to their money for an extended period.
- Minimum investment: Often as low as $500, though "jumbo CDs" paying competitive rates may require $25,000 or more.
- Pros: Generally, higher rates than savings accounts, with FDIC insurance.
- Cons: Less liquid than a savings account: You will pay a penalty for early withdrawal.
- Risk: Essentially none up to $100,000, thanks to the FDIC.
Upshot: Another strong contender, with more security and less liquidity than a money market fund. Read Dan's article to learn much more, and be sure to review the latest rates to find strong offerings from institutions such as Bank of Internet USA
(NASDAQ:BOFI), Amtrust Direct, and Netbank (NASDAQ:NTBK).
Bonds and bond mutual funds
Short-term bond funds, and bonds that are a year or two away from maturity, are a somewhat more aggressive choice than money market funds and CDs. I wrote about bonds and bond funds last month; check out that article for more thoughts on buying bonds directly. It's not hard to do.
- Minimum investment: Varies.
- Pros: Rates may exceed those available from other "short-term" investments. Municipal bonds and bond funds offer tax advantages that may be especially appealing to wealthier Fools.
- Cons: Bond funds are exposed to market risk. Share prices will fluctuate, and you can lose money. Direct investments in bonds are as risky as the credit rating of the issuer.
- Risk: See above.
- Upshot: Although the risk of losing a big chunk of your original investment is pretty low, it isn't zero. The yield advantage over money market funds isn't usually that great, but it might be worth a look before you commit to another option.
How much interest is your cookie jar paying these days? This non-yielding option can be surprisingly risky, especially if you own a big dog that likes to eat cookies.
- Minimum investment: Just a penny!
- Pros: You can go into the kitchen and actually look at your money any time you like, day or night.
- Cons: So can anyone else who visits. And really, you don't want to deal with a big dog that just ate a pile of money and is having an upset tummy.
- Risk: You won't keep pace with inflation, anyone who passes through your kitchen can raid the cookie jar, and the dog might leave a mess.
- Upshot: Take it to the bank, Fool.
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Fool contributor John Rosevear is always careful to keep his money away from big cookie-loving dogs. He doesn't own shares of the companies mentioned in this article. Bank of America is an Income Investor recommendation. The Motley Fool's disclosure policy never, ever raids the cookie jar without asking.