Dec. 19, 2018
NEW YORK, Dec 18 (Reuters) - Would you sacrifice the safety of your savings for $60?
Last week investing startup Robinhood announced a market-leading checking and savings account paying 3 percent interest, a jump ahead of the current top rate of around 2.4 percent from the most aggressive high-yield savings accounts.
Social media went into a tizzy about the fine print. After regulators expressed caution, Robinhood pulled its offer.
The catch was that, as Robinhood touted on its website, deposits up to $250,000 in cash were to be insured by the Securities Investor Protection Corporation, which is not the same as bank deposits insured by the Federal Deposit Insurance Corporation.
It sounds like semantics, but it is actually a big deal.
An account insured by SIPC is an investment account, which comes with risk. The insurance only kicks in if the brokerage company goes out of business or is otherwise disabled.
It covers the return of what the investment is worth at that moment. If you invested $1000, and at the time the company went out of business is was worth only $950, you get only $950.
By contrast, cash in a bank with FDIC insurance is protected, along with the promised interest. If the bank goes under, you get your money back, dollar for dollar, up to $250,000 per account type.
Banks still do go under, just to refresh your memory. While there have been no failures so far in 2018, there were eight last year and dozens in the last 10 years.
So where does that $60 come into play?
At 2.4 percent, you could expect to earn $240 on $10,000 after a year. At 3 percent, you would have $300.
For a company like Robinhood to offer 3 percent interest when the rest of the country tops out at 2.4 percent means there is some kind of risk involved, says Greg McBride, chief financial analyst for Bankrate.com.
Your money is going to be invested in a financial product. Even if it is a presumed "safe" investment, it is still subject to potential catastrophe.
"There's no free lunch," said McBride. "Money funds are not yet paying 3 percent, so that return has to come from somewhere."
DO THE MATH
Say you have $10,000 in an emergency fund and you want to know the best way to stash it so it stays liquid and earns the most interest without the risk of losing value. You can search on the web at a site like Bankrate.com for the best rates, which have been fluctuating between 2.25 and 2.4 percent.
"If it’s an internet-based bank and one you’ve never heard of, it’s still the same regulations as every other bank," said McBride.
Anything else is investing.
Brokerage companies do regularly manage cash. Financial adviser Jude Boudreaux, who is based in New Orleans, said the way most deal with cash on hand is to sweep accounts every day and put any excess cash waiting to be re-invested into FDIC-insured bank accounts. But that is usually a fleeting situation and not a long-term investing strategy.
Beyond emergency funds that need to be safe and as liquid as possible, the rest of one's holdings should be balanced according to individual needs - taking into account age, risk tolerance and other factors that pertain to their particular situation.
"People have always looked for ways to increase return without increasing risk," said Boudreaux. "The question is: What are we doing to make that happen?"
For those really intent on a 3 percent cash return, experts say they should wait rather than give up security for a little extra money. With interest rates rising, banks will keep paying more.
If you can tie up your money for a year, CDs offer slightly higher rates without increasing risk. The most efficient way to invest is to pump portions of your cash into individual CDs as rates keep rising, which is called laddering. Beyond that, use stocks and bonds for long-term investments, while recognizing that neither asset class is guaranteed.
"It’s kind of like driving faster: You get there sooner, but you have higher risk," McBride said. (Editing by Lauren Young and Dan Grebler)
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