Interest rates have slowly inched up in the past couple of years, but they’re still very low by historic standards. The low rates that have helped you save money on a mortgage or student loan refinance have a downside: Cash stashed away in safe places — savings accounts, CDs and money market accounts — probably isn’t earning a notable return.
Money you may need within five years generally shouldn’t be invested in the stock market because that time horizon isn’t long enough to recover from a downturn. With that option off the table, it’s a struggle for short-term money to keep pace with inflation — and that’s unlikely to change until interest rates rise more substantially.
In the meantime, you should strive to earn every cent possible without locking up your cash in a way that will prevent you from taking advantage of higher rates when they come. (For instance, think twice about long-term CDs, which hit you with an interest penalty if you attempt to withdraw your investment before the end of the term.)
Here’s a guide for the best accounts to park money depending on your timeline:
|When you need the money||Where to put it||Potential interest rate||Risk||Reward|
|Less than two years||Online savings or money market accounts||1% or slightly more||Low||Low, but better than the average at traditional banks|
|Two to three years||Short-term bond funds or money market mutual funds||1% or more, for those willing to take on more risk||Moderate — can reduce risks via selection||Low-medium, depending on bond or fund risk|
|Three to five years||Peer-to-peer loans||5%||Moderate — can reduce risks via selection||Medium-high, you’ll be helping fund borrowers|
|Any time period, but you also have high-interest debt||Pay down (or pay off) the debt||Your current debt interest rate||Low||High, given the cuts in interest costs|
Money you need in less than 2 years
ONLINE SAVINGS OR MONEY MARKET ACCOUNTS
Potential interest rate: 1% or slightly more
Find the banks and credit unions that pay the best interest rates using NerdWallet’s savings account search tool — with many offering rates of 1% or more. That doesn’t sound like much until you compare it to 0.06%, the current national average interest rate on savings accounts, according to the FDIC — and what you’ll likely be offered at your hometown branch.
The same goes for money market accounts: Online you’ll see rates of 1%-plus; FDIC data show the national average here is 0.08%. Unlike savings accounts, money market accounts tend to have higher deposit requirements and come with checks and debit cards, but both savings and money market accounts are FDIC-insured, meaning your money is protected in the event of a bank failure up to $250,000 per institution, per depositor.
Money you need in 2 to 3 years
SHORT-TERM BOND FUNDS OR MONEY MARKET MUTUAL FUNDS
Potential interest rate: 1% or more, for those willing to take on more risk.
Bonds allow you to lend money to a company or government, which then pays you back with interest. They’re not risk-free: The borrower could default, and when interest rates rise, bond values typically go down. To reduce the risk of default, choose bond funds that primarily own government bonds, which are issued by the U.S. government, and municipal bonds, which are issued by states and cities.
Another option are money market mutual funds, also known as money market funds. Not to be confused with similarly named money market accounts (above), money market funds are mutual funds that purchase short-term, high-quality debt from the U.S. government, municipalities or corporations. There also can be tax benefits, as some money market funds hold municipal securities that are exempt from federal and state taxes. Unlike money market accounts, these funds are not FDIC-insured and carry similar risks as short-term bonds.
You can purchase bond funds or money market funds via an online brokerage account.
» Ready to get started? Find the best brokerage account
Money you need in 3 to 5 years
Potential interest rate: 5% or more
Online lenders like Prosper and Lending Club are options for investors who are willing to lend money to borrowers who need cash to fund things from home renovations to medical expenses.
On both sites, borrowers are classified by creditworthiness, which means you can limit risk — but not avoid it completely — by choosing to lend only to borrowers in the upper credit tiers. You’ll earn less in interest focusing on these choice candidates, but the return still is substantially greater than a savings account. Lending Club says historical returns on loans graded A are 4.89%; Prosper’s top credit class, AA, has estimated returns of 4.15%.
To lower risk further, diversify by spreading loans around into small chunks, lending $25 or $50 to each candidate rather than, say, $2,500 to one. Both services say investors who invest in 100 or more loans have close to a 100% chance of seeing positive returns. When a borrower makes a payment, it’s distributed to the loan’s investors and you can either withdraw or reinvest it. Loan terms start at three years and require minimum investments of $25. Investors also pay a service fee on both platforms, so be sure to note that in your calculations.
Where to put money if you have high-interest-rate debt
PAY DOWN (OR PAY OFF) THE DEBT
Potential interest rate: Your current debt interest rate
Want to earn double-digit returns on your investment? Pay off high-interest-rate debt.
When you pay off high-interest credit card debt, personal loans or other expensive debt, the return is equal to the interest rate you would’ve otherwise owed by paying that debt off slowly over time. If you can wipe out a $2,000 credit card balance at a 13% interest rate, you’ll save around $900 by not carrying that debt and making minimum payments with interest over five or six years. Best of all, directing your short-term cash toward this option gives you a guaranteed rate of return.
This is why many financial advisors suggest people who have substantial savings and also credit card debt use at least a portion of that savings to pay it down.
» Have stacks of credit-card bills? Consider your best debt options
More on building your savings from NerdWallet:
Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: email@example.com. Twitter: @arioshea. Staff writer Anna-Louise Jackson also contributed to this report. Email: firstname.lastname@example.org. Twitter: @aljax7.
Updated July 31, 2017.