How to Maximize Your Interest Yields in a Low-Interest-Rate World

At least for now, gone are the days of earning a solid 5-percent interest rate in money market accounts or certificates of deposit. However, there are some still things you can do to help maximize your interest rate on cash stashed away for a rainy day.

First and foremost, consider putting the cash to work paying down or paying off debt. You want to be sure not to compromise your emergency fund, but if you have cash stowed away for a home purchase 3-4 years away that is earning 2%, but are paying 9% on a car loan or far worse on a credit card, you might be better off using the savings to pay off that debt. Just as a famous guy once said, “A penny saved is a penny earned”, the 7% interest you are saving is just like earning 7% interest. But, you must have the discipline to replenish your savings with the money you once used for the debt payment. This is a theory my wife and I dubbed “the fake car payment”. See, when we would pay off a car, we would continue to make a payment, equal to what the car payment was, into a savings account. That way, you will actually save the extra cash on hand at the end of the month, instead of absorbing it into your everyday spending.

Next, decide what type of savings vehicle best suits your needs. What are you saving for? Your 3-6 month emergency fund should be kept at the ready for deployment in the event of an emergency, while the down payment for you house 3-4 years away doesn’t have to be as liquid. For short-term goals, savings account or money market account will be the best bet, though likely not the best income producer. For the longer term goals, consider a short-term bond fund or a CD.

When you decide which savings vehicle is right for you, you need to shop around to find the best rates. According to www.bankrate.com, the top 10 yielding money markets range from 3.2% to 2.24% yield. That’s a full point difference! Similar differences are present for savings accounts and CDs. Be wary of fees, which will quickly eat away any difference in interest rates.

While you are shopping around, look at other features. Sometimes adding a direct deposit or having multiple accounts will give you a slightly higher yield. Electing an account with a higher minimum balance will also increase your yield, so if you have money scattered across multiple accounts, it might behoove you to consolidate them into one account with a higher minimum balance.

Does the account offer check writing? If so, you can keep you budget amount for larger purchases such as mortgages, car payments, paying off the credit card monthly (which you are doing, right?). This way, the funds allocated for these larger purchases will earn interest until the bill is due and the check clears. Just be sure you don’t exceed the number of allowed checks, or write a check that is less than any minimum dollar amount that may be required.

Brace yourselves; the next thing we need to think about is taxes. Keep in mind that you will most likely have to pay taxes on all of the interest income you will start to amass. That is, unless you invest in a tax-free account. Tax free accounts of various shapes and sizes will pay a lower interest rate, but that may be offset by the fact that the interest is tax free. Consider this, you if you put your savings in a money market account making 3% and you are in the 25% tax bracket, you are actually making 2.25% after the tax man is done with your wallet. It is may be possible to find a tax-free money market fund that pays more than 2.25%. You will receive less in interest each month, but you won’t have to share with the IRS. If you’re in a higher tax bracket, it only makes more sense to do this because Uncle Sam’s cut is more. If you’re in a lower tax bracket, it may be a wash.

My current strategy is to keep enough money in my Pay Pal account, which earns around 2.9% to cover all my daily expenses. Using my Pay Pal debit card, I earn a 1.5% cash rebate on all signature purchases. I’ll keep the bare minimum in my checking account to cover my bills that I can’t pay with my Pay Pal card. It earns a fraction of a percent only because I have direct deposit into that account. Anything over the bare minimum I can get away with without bouncing checks is swept between a short-term municipal bond fund or a municipal money market fund-these each earn about 2.5% tax-free. I like the municipal bond fund because I have the potential for capital gains as interest rates continue to decline, while I like the money market account for capital preservation. These are relatively new accounts that haven’t been activated for check-writing yet. When (if) they are, I will use the 6 free checks a month to cover larger bills so, as I mentioned earlier, I can earn interest on those budgeted amounts until they clear. I say “if” because I admit that I have hated writing checks ever since I got hooked on online bill payments.

My strategy doesn’t earn a whopping amount, but it does the best it can in a low-interest rate environment. With a little planning, you too can push your savings to work a little harder, so eventually you will not have to. If you have any other ideas, please add a comment-I’m always looking for ways to make my money work harder still. Just don’t mention ING Direct. I have intentionally excluded them because of a grudge.