By Kirk Kinder
Learn more about Kirk on NerdWallet’s Ask an Advisor
There’s no doubt that the returns you can find on cash holdings these days are less than attractive. Traditional bank savings vehicles — such as checking 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 some ways you may be able to get better returns without taking on too much additional risk.
The first option is I savings bonds, or I-bonds. They’re issued and guaranteed by the U.S. government, and their returns consist of two components. The first is an interest rate that remains fixed for as long as you own the bond — currently at 0%. 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% during the past year, but that still beats the returns you’d receive on many money market accounts and even some long-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 worth each 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’re not an appropriate place to keep immediate living expenses — but then, neither are longer term CDs. Finally, if you redeem the bonds within the first five years, you won’t receive the last three months of interest. Even with that penalty, they often still yield more than traditional bank savings vehicles.
Another option is peer-to-peer lending. These platforms let you play the role of the banker, loaning money directly to borrowers. With the banks cut out of the equation, you receive a 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 several small loans or asking the 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 Club are two of the most popular peer-to-peer lending platforms; they’ve been around since 2006 and 2007, respectively. The industry is still quite new compared with the traditional banking system, so it has its growing pains, and you should be sure you’re comfortable 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 federal backing might scare 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 than 1% 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. Ask your state’s securities regulator if it is in yours.
Even without FDIC backing, and acknowledging the default risk and lack of liquidity, peer-to-peer lending is worth considering as an alternative to savings options such as money 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 that in 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.