How to Diversify Your Savings for the Best Rates and Optimal Returns
There’s a good chance you’ve heard the old saying, “Don’t put all your eggs in one basket.” It reinforces the importance of diversification in all aspects of your life, including your finances.
While diversifying your cash savings takes time and effort, it’s worth it. Let’s take a closer look at what diversification is and why it’s essential.
What Is Diversification?
In personal finance, diversification is when you spread your money around so that it’s not all tied up in one place.
If you’re investing with a retirement account, like a 401(k) or an IRA, you’re likely already practicing this strategy. You might have several types of investments, such as stocks, bonds, mutual funds, index funds, exchange-traded funds (ETFs), and even real estate.
While this is great, you should know that investments are only one of many types of assets that can be diversified. You may also diversify some of your cash assets and allocate them across several savings accounts from various federally insured banks and credit unions.
By doing so, you’ll be able to earn interest without the high risk that often comes with stock market investments. You’ll also enjoy the peace of mind of knowing your cash is protected by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA).
In addition, you’ll find it easier to access your cash when needed, as cash savings accounts typically allow for greater liquidity than investment accounts.
Which Banks Have the Best CD Rates?
Hundreds of banks offer CDs, and there’s fierce competition among them to offer the best rates. We’ve compiled a list of some of the best CD accounts to help you find the ones that best fit your financial goals.
Types of Cash Savings Accounts
Not all cash savings accounts are created equal. That’s why shopping around and comparing all your options is a good idea. Here are several accounts you might want to explore as you determine how to diversify your cash assets:
High-Yield Savings Accounts
Also known as a high-interest account, a high-yield savings account offers an annual percentage yield (APY) higher than the national average.
As with traditional savings accounts, interest rates for high-yield savings accounts fluctuate and depend on market conditions. With a high-yield savings account, you can build up your savings and easily withdraw funds when needed.
A fixed-term certificate of deposit (CD) is a traditional CD that allows you to lock in a competitive interest rate for a fixed period.
This type of savings account makes it a breeze to predict your returns. However, you must agree to keep your cash in the account for a term that may be anywhere between a few months to several years.
Generally, the longer the term, the higher the interest rate. If you withdraw your money before the term ends, you’ll be charged a penalty.
Like a fixed-term CD, a no-penalty CD requires you to park your cash in an account for a set term.
However, with a no-penalty CD, you don’t have to pay a penalty if you withdraw your money before the period ends or the CD matures.
While this flexibility can be very beneficial, you’ll likely have to settle for a lower interest rate than with a fixed-term or traditional CD.
Depending on the financial institution, you may also have to withdraw all of your funds (instead of some of them) and close the account.
Money Market Accounts
Also referred to as a money market savings account or money market deposit account, a money market account earns interest but often offers some checking account features.
With a money market account, you might be able to write checks or use a debit card to make withdrawals or purchases.
Sometimes, you’ll have to meet a minimum deposit requirement to open this type of account and may owe fees for monthly maintenance or check writing.
Available through TreasuryDirect.gov, a treasury bill or T-bill is issued by the U.S. government with maturities ranging from a few days to 52 weeks.
Even though it will likely pay out a lower yield than a high-yield savings account, it’s backed by the government and a safe place to park your cash for a short period. You can keep a T-bill until it matures or sell it before it develops.
Rebalance Your Cash Savings
Ideally, you’d choose at least a few cash savings accounts to diversify your cash assets. You can also open the same type of account in multiple places and take advantage of different competitive interest rates and other perks. Regardless, it’s important to rebalance your cash savings regularly, just like you may do with your investments.
Let’s say you initially put half of your cash in a high-yield savings account and spread the other half across CDs.
After some time, liquidity may be less important to you, and you may want to focus on saving for significant expenses, like a house down payment.
In this case, you allocate more of your cash to CDs so you can take advantage of the higher rates. If you need help with rebalancing, you can consult a financial professional.
How to Diversify Your CD Accounts
If you decide that CDs are a good fit for your unique goals and preferences, these strategies can help you diversify them:
A CD ladder is when you purchase several CDs with staggered terms or maturities. With this strategy, you can enjoy the higher rates of longer-term CDs while keeping your money accessible.
Let’s say you have $5,000 you can allocate toward a CD ladder. You can divvy up the $5,000 into five CDs like this:
- $1,000 in a one-year CD
- $1,000 in a two-year CD
- $1,000 in a three-year CD
- $1,000 in a four-year CD
- $1,000 in a five-year CD
Once the one-year CD reaches the end of its term or matures, you can reinvest that $1,000 plus interest it earned into a two-year CD.
You should repeat this until you have a five-year CD maturing yearly. However, if you need access to your funds one year, you can always withdraw them from the next CD to mature.
This way, you won’t have to renew or reinvest funds into a new CD.
A CD barbell is when you split an investment into short and long-term CDs and don’t include any CDs with midrange terms. When the short-term CDs mature, you can reinvest the funds in short-term or long-term CDs, depending on whether rates have increased.
If you have $5,000, you can divide your investment into two CDs like this:
- $2,500 into a six-month CD
- $2,500 into a five-year CD
Once the six-month CD matures, research and look for CD rates at different financial institutions. If five-year rates have increased, reinvest the money in a five-year CD. You’ll want to reinvest the $2,500 plus interest into another six-month CD if they haven’t risen.
A CD bullet is a strategy for buying CDs that mature at the same time.
If you open the CDs over time, the new terms will be shorter than those you first invested in. Also, you won’t have to reinvest, like you would with a CD ladder or CD barbells.
When all the CDs mature, the money will be available to you. This strategy may be worthwhile if you want to save for a significant expense. It may look like this:
- $5,000 in a five-year CD
- $2,500 in a three-year CD in the second year
- $2,500 in a one-year CD in the fourth year
How to Balance Your CD Accounts with High-Yield Savings Accounts and Money Market Accounts
If you’re saving up for a significant expense, like a house, car, or wedding, CDs can be very beneficial, especially fixed-rate or traditional CDs with attractive rates.
However, you shouldn’t deposit your money into CDs as you may need to access them before they mature. It’s a good idea to put some of your cash into a high-yield savings account, for example, to cover emergencies and other expenses without penalty.
In addition, you can park your emergency fund, down payment fund, or travel fund in a money market account and enjoy easy access to cash while still earning interest and being able to write checks and use a debit or ATM card, like you would with a traditional checking account.
Unlike stocks and other volatile assets, a money market account is low-risk as interest rates tend to go up when interest rates rise.
You can make the most of your hard-earned money by diversifying your cash assets.
You’ll also find it easier to cover emergency and planned expenses while saving for the future.
Frequently Asked Questions
The FDIC offers federal deposit insurance for banks, while the NCUA provides it for credit unions. If a bank or credit union fails, this type of insurance will keep your cash assets safe and sound. Generally, the coverage amount is limited to $250,000 per depositor, institution, and account ownership category.
No. It’s a good idea to shop around and find multiple banks, credit unions, or other institutions with competitive rates for your cash. You can always open a high-yield savings account at one bank and CDs at a credit union that offers higher rates.
Online banks and credit unions usually offer the most impressive rates on cash accounts. This is because they have less overhead than brick-and-mortar institutions. Do your research to determine which accounts will pay out the most.