Just the other day, two friends reached out with an investment question, sparking the perfect inspiration for this week’s edition of The Boost.
Remember, when it comes to investing, nobody's a "dummy." Finance is a big, complicated, ever-changing world, and we’re all continuously learning together. I personally learned something new from this question and even made some of my own moves with my cash while writing this.
Important Background: Despite a recent dip, interest rates are still close to their peak levels over the past one and five years, as indicated in this chart of the US 10 Year treasury yield.
It’s no surprise that many are seeking to earn extra yield. Meanwhile, the stock market is also close to all-time highs. This naturally leads some to consider lower-risk investments. This week, we focus on a few of the least risky ways to capture additional yield in your portfolio.
🧠 What you need to know
There's a multitude of paths to earn passive income or 'yield.' These options vary in terms of principal risk - the likelihood of your initial investment (say, $100) depreciating even as you earn, for example, a 5% annual yield.
💡Low risk ways to capture yield
Here are five yield-generating investments with minimal principal risk. In many cases, but not always, you will earn higher interest rates as you go down the list.
- High-Yield Savings Accounts (HYSA): Provide better interest rates than checking or standard savings accounts, but sometimes have withdrawal restrictions. You can’t write a check. They also carry FDIC insurance. Here’s an example of an offering from American Express.
- Money Market Accounts (MMAs): Offer higher interest rates than traditional savings accounts and check-writing privileges, but may require higher minimum balances and limit transactions.They also carry FDIC insurance. Here’s a comparison of Ally Bank’s MMA and HYSA.
- Money Market Funds (MMFs): Investment funds targeting short-term debt securities. They are considered to be very safe, but there is greater risk, particularly in periods of market duress like in 2008. They also lack FDIC insurance. They may have higher fees; for example, Fidelity’s SPAXX carries a 5% yield but a 0.42% expense ratio, making it only slightly better than Ally Bank’s money market account. You can generally invest in these through your brokerage account, including retirement accounts. Fidelity even provides hte option to automatically put your cash in SPAXX.
- Certificates of Deposit (CDs): When you invest in a CD, you agree to leave your money deposited for a pre-specified period, which can range from a few months to several years. In return, the bank provides a higher interest rate compared to regular savings accounts. The key feature of CDs is their fixed term and fixed interest rate, offering a predictable return. However, early withdrawal from a CD typically incurs a penalty, making it less flexible than other options.
- Treasury Bonds: Treasury Bonds are long-term government debt securities with maturities typically ranging from 20 to 30 years. They pay interest every six months until they mature, at which point the holder receives the bond's face value. Like Treasury Bills, bonds are backed by the U.S. government, making them a very low-risk investment. If you don’t held them to maturity, however, then you will incur principal risk, so there is less flexibility than savings accounts.
Let’s contrast these with a high-yielding dividend ETF like the Vanguard High Dividend ETF (VYM). While it pays a dividend yield of nearly 3.5%, it has also traded down 6% over the past year. However, over the past three years, it is up over 18%. It definitely comes with a lot more volatility, thus risk, than the savings account. Over three years, a $10,000 investment in:
- A high-yield savings account yielding 5% would have provided $1,500 in interest income, assuming no reinvestment.
- An investment in VYM would have returned approximately $1,050 in dividend income, assuming no reinvestment, and $1,800 in appreciation, totaling a return of $2,950.
Note, this is a very simplistic comparison. A few issues to keep in mind:
- Timing can highly influence returns.
- In reality, you would have earned less than 5% interest each year, as interest rates have fluctuated.
- The dividends paid could also fluctuate based on the dividends paid by the underlying holdings.
Check out this prior edition of The Boost for insights on returns from investing in the stock market versus earning interest from the above-mentioned types of investments, as well as the tax implications of generating interest from passive income. Another consideration: interest rates could keep falling.
Disclaimer: Mezzi doesn't endorse any specific offerings from American Express, Ally, or Vanguard. These examples are merely for illustrative purposes.
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🤝 How can Mezzi help?
Today, I personally use Mezzi to:
- Manage my cash balance
- Optimize my passive income in taxable and tax-advantaged accounts like my IRA
- Compare my returns from passive income to appreciation in my investments
- Ensure I’m in the lowest cost funds for generating yield
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