By Kirk Kinder
Learn more about Kirk on NerdWallet’s Ask an Advisor
There’s no doubt that the returns you can find oncash holdings these days are less than attractive. Traditional bank savings vehicles —such aschecking accounts, savings accounts, money market deposit accounts and certificates of deposit— often yield less than 1% per year. Longer-term CDs — say, three years — occasionally yield closer to 1.5%.
You don’t have to accept those paltry rates. There are someways you may be able to get better returns without taking on too much additional risk.I-bonds
The first option is I savings bonds, or I-bonds. They’re issued and guaranteed by the U.S. government, and theirreturns consist of two components. The first is aninterest ratethatremains fixedfor as long as you own the bond — currentlyat0%. So why in the world would you want one? The answer is the second component of the return: a variable inflation rate, hence the “I” in I-bond.The rate is adjusted twice per year.
Over the past few years, the total return on these bonds has surpassed 3% at times.The inflation component has returned just 0.85% duringthe past year, but that still beats the returns you’d receive on many money market accountsandeven somelong-dated CDs. The gains are also exempt from state and local taxes, and you can defer federal taxes until you redeem the bonds.
But there are downsides to I-bonds. First, you can only buy $10,000 wortheach year. Married couples can bump this up to $20,000. You also have to hold I-bonds for at least one year, which means they’renot an appropriate place to keep immediate living expenses — but then, neither are longer term CDs. Finally, if you redeem the bonds within the firstfive years, you won’treceive the last three months of interest. Even with that penalty, they often still yield more than traditional bank savings vehicles.Peer-to-peer lending
Anotheroption is peer-to-peer lending. Theseplatforms let you play the role of the banker, loaning money directly to borrowers. With the banks cut out of the equation, you receivea higher return and borrowers pay lower costs.
Peer-to-peer lending platforms conduct credit analyses on borrowers, and you can review each borrower’s profile before deciding whether to invest.You can also diversify your investment by making severalsmall loans or askingthe company to pick loans for you using credit or interest rate criteria you set. Of course, these investments aren’t backed by the Federal Deposit Insurance Corp. the way checking, savings and money market accounts and CDs are.
Prosper and Lending Clubare two of the most popular peer-to-peer lending platforms; they’ve been around since 2006 and 2007, respectively. The industryis still quite new compared with the traditional banking system, so it hasits growing pains, andyou should be sure you’recomfortable with that before investing. That said, Lending Club and Prosper have successfully loaned individuals billions of dollars.
Lending money to people you don’t know or losing federalbacking mightscare you. But peer-to-peer companies have years of data on default rates, which are quite low for the highest-graded loans. According to Lending Club, less than1% of the total issue amount of A-graded loans was charged off between Q1 2007 and Q2 2016. And with annualized returns of about 5%, those top-graded loans still trump traditional savings options even with the risk of default.
The loans’ potential illiquidity is another downside. Platforms exist to sell the loans, but you might not find a buyer or get the full value of the loan. And peer-to-peer lending isn’t authorized in every state. Askyour state’s securities regulator if it is in yours.
Even without FDIC backing, and acknowledgingthe default risk and lack of liquidity, peer-to-peer lending is worth consideringas an alternative to savings options such asmoney market accounts and CDs.Escaping low yields
If you have three to six months of emergency savings safely socked away, you can consider investing any savings beyond thatin these alternatives. You still need to keep enough cash in your checking, saving or money market accounts or short-term CDs to cover immediate expenses, but if you’re looking to escape the low-yield universe of bank savings accounts, you may want to explore these options.
This article also appears on Nasdaq.