5 Tax-Smart Alternatives That Beat High-Yield Savings Accounts

Hey everybody, and welcome to another episode of the Financially Free Physician Podcast. I am your host, Sim Terwilliger, and today I have a special guest joining us, Jared Costigan. Welcome, Jared. What is up, everybody? I'm Jared Costigan. I'm one of the financial planners at SLP Wealth, a member of the investment committee, and super excited to be here today, Sim. What are we talking about? We're going to take a really fascinating subject. We're going to be talking about five alternatives to your high-yield savings account, and I actually think this is really important, even though some people may kind of, you know, hear that and be like, this is kind of boring, but it really matters, especially if you are a high-income earner like physicians. But I wanted to start this off with a joke. The problem is, Jared and I couldn't think of a joke for this podcast, except the interest rate perhaps you may be getting on your checking account or savings account. Oh man, that's why we're here today. Yeah, we're here to entertain you and be comedians. But okay, so in the financial blogosphere, right, everyone talks about the high-yield savings account. We're going to talk about some alternatives, but before we talk about the alternatives, Jared, can you kind of unpack for us a little bit, what makes the high-yield savings account so special? Yeah, in the current interest rate environment, if your Chase or Bank of America or your big box bank is paying you like 0.01%, 0.10% in your checking and savings account, there is money to be made on your cash that is sitting relatively idle. There are lots of different instruments out there to be getting a yield in the range of 4% or 5% in today's interest rate environment. So for people that have a lot of cash, whether that's like your emergency fund, or you're planning to buy a house soon, or you're saving up to buy a business or buy into a practice, if there are significant sums of money sitting in your big box bank account earning 0.10%, you're leaving money on the table. High-yield savings account is a really easy way to get some yield from your cash. Interest rates are somewhere in the range of 4% or 4.5% now. And we're in a really exciting time to be talking about this, Sim, because just recently, the Federal Reserve cut interest rates. And if I could talk about anything more boring, I don't know that we would be having a fun time here. Like I just picture the guy that says like Bueller, Bueller, like talking about the Federal Reserve. And he kind of looks like Ben Bernanke, who is the former head of the Federal Reserve. All of that jargon does really have an impact on your personal finances. And a high-yield savings account is a way to start getting yield from your money that's waiting to be deployed, or it's there to protect you. And you're leaving money on the table if you're just sitting in a checking account or a savings account. I think that's great. And I think that, you know, all the jargon aside, I mean, you can get super techie talking about stuff like this, but it's really important to translate like this makes dollars and cents to you as an individual. This impacts what you're able to take in for your family. So let's just jump into it. Got top five alternatives to your high-yield savings accounts. Let's talk about number one, the money market account. What is that? If you have a brokerage account, there are mutual funds that act a lot like a high-yield savings account. Some of the popular ones are like Vanguard's money market fund, Fidelity's money market fund. And when you compare the yields on those funds to what you would get at a high-yield savings account, like Ally or Altruist or Capital One, it tends to be a higher current yield in those money market accounts. So if you have a brokerage account, you can go buy this mutual fund. And right now it's paying around 5%. The high-yield savings accounts are paying somewhere in the range of like four and a half percent. There's a wide range. And we recorded this on September 26th. So interest rates may have changed since you're hearing this. The situation is fluid. Yes. As always, as always, the interest rate situation is always fluid. And that's why we're talking about how to protect your interest and your yield. The money market fund pays more in general than the high-yield savings account. And the reason for that is your high-yield savings account is FDIC insured. If you have, as an individual, less than $250,000 in one bank, and that bank were to fail, the federal government would step in and they insure your deposits. They would make you whole. A money market account does not have FDIC insurance. It is a basket of fixed income, a basket of bonds, or we call it a fund of funds. All of those bonds are paying interest to the fund manager. And they pass that interest on to you, the investor. In a money market fund, if the bond holder, so that could be the U.S. government, it could be a corporate company. It could be foreign governments. If that person doesn't pay back their debt, because that's what a bond is, is debt, but you're the lender in this scenario. If they don't pay you back, you might not be made whole. You can lose money in bonds. If the person that is responsible for paying their debts back defaults, that's where the lender or the bond holder can lose money. The money market funds that we're talking about here are very low risk compared to some of the other bonds that we'll talk about, but that's the big difference is that a high yield savings account is insured by FDIC insurance. Money market fund, there is some risk of principal loss. Jared, that's great. Let's talk about this new product that I've been hearing about from a lot of our clients, which is a no penalty CD. Awesome. Yeah, this is pretty new. Typically, CD stands for a certificate of deposit. They are FDIC insured. They're issued by a lot of the same banks that we've been talking about, including the big box ones, Chase Bank of America, et cetera, and also the high yield savings account providers like Ally and Capital One and those guys. Typically, a certificate of deposit has a set amount of time that the money has to stay in there for. You can buy a nine month CD. You can buy a two year CD. You can buy a one year CD. If I buy a one year CD that pays a 5% interest rate, most CDs, if I try to withdraw that money before the one year matures, there is a penalty to take it out. Now we're seeing these new products where there are no penalties, but you do get that fixed interest rate locked in, regardless of what's happening in the interest rate market around that. So if interest rates are 5% on a one year CD right now, there's no saying that it's still going to be 5% six months from now. But if I locked that in, I'm able to keep that interest rate for a longer period of time. These no penalty CDs, that's really cool because in the past, we would generally shy away from CDs because they're not as liquid. But if you have the opportunity to lock in an interest rate for a set amount of time and if an emergency happens, if that home purchase that you were planning on ends up happening sooner, because the perfect place down the street, the perfect home that you were looking for shows up on the market and you're like, Oh man, I didn't think I was going to buy this house for another two years, but here we are six months after I bought this CD. I need this money. That's great. If you can withdraw it for no penalty and that is FDIC insured. So you can expect that those interest rates are going to be a little bit lower than the money market fund or some other bond funds that we're going to talk about. Jared, you just described me in that scenario. I'm like, please God, let that be me finding that perfect house. We are so cramped here. I'm like, we're going to be stuck here forever. I'm like always casually looking, have not found the home yet. But with the no penalty CD, I would say that, you know, because it is a newer product and it sounds very promising, just always read the fine print, read everything. Any financial account you open, read everything. They send you a bunch of disclosures for a reason. So do that. Okay. Number three, third alternative to your high-yield savings account, short-term bond funds slash munis. Oh, this is where it gets really exciting, Sam. Yeah. I also feel like you kind of almost just break those into like their own categories. Maybe like I lied about the title. Maybe it's six alternatives to your high-yield savings account. I tricked you. Good point. High-yield savings account, money market funds, CDs, everything we've talked about to this point. The bonds that you are buying in those very short, short-term funds or the bonds underlying your high-yield savings account. They are very short-term like seven days, 14 days, maybe 21 days. We're at a cool point in history where. The fed just cut interest rates by a half a percent for the first time in like a year and a half. If you had a high-yield savings account and it was paying 5% and you put that money in a month ago and you look at it today, now it's paying four and a half percent. So the interest rate is fluid. It can be updated day to day. When you start buying bonds that mature over a longer period of time, a short-term bond could be anywhere from three months to three years. The underlying bonds in that fund have that interest rate locked in with the current market rates. If interest rates in the market go down because of something like a federal reserve cut, you already own that bond that's locked in the rate until it matures or expires. So if I lend a thousand dollars to my friend and I say, Hey, pay me back in two years, pay me a 5% interest on that. And then my friend down the street, uh, friend B says, Hey, I want to borrow a thousand dollars. Can I borrow a thousand dollars? And I'm like, sure. Yeah. Now I'm going to lend you that. Pay me 4% interest and pay me the thousand dollars back in two years. The friend that got the loan from me that he's paying 5%, he's like, Hey, what the heck? He got a way better deal. But me as the lender in that scenario, I got a better deal on the 5% friend, friend A, and that's a fixed contract. When the market changes, I'm already locked in to that higher interest rate. So what we're seeing with these short-term bond funds is maybe they don't pay quite as much as a high yield savings account because we're in an inverted yield curve environment. That's a podcast episode for another time. Bring your coffee. Yeah. Oh, I mean, I, I still, I picture like Ben Bernanke at a, at a podium talking about finance and they're like inverted yield curve and high yield savings account. Everyone's going to be Googling that after this episode. Yeah. So a short-term bond fund, they pay a little bit less than the current environment. But if we're sitting here a year from now and interest rates are 1% lower, now my high yield savings accounts only pay me 3%. But I locked in a 4% yield for two or three years with the short-term bond fund. That's a really great opportunity. And the really boring, nerdy finance phrase for that is duration. Bond funds can allow you to get more duration or to keep that interest rate for a little bit longer period of time. Jared, I'm going to regret asking this, but I'm going to do it anyway. Maybe you can do like an explain like I'm five, right? But there's an inverse relationship between interest rates and bond prices. Do you want to just like very quickly elaborate on that and why that matters? Yeah. So my friend A got a thousand dollars from me. He pays me 5% every year. He pays Jared $50 every year. And then at the end of two years, he has to pay the full thousand dollars back. Friend B got a better deal. He borrowed a thousand dollars from Jared. He pays Jared $40 a year to borrow that. And at the end of two years, he has to pay back the full thousand dollars. So friend C comes along and he's like, Hey, I want to invest in friend A's bond. Like I want to buy that from friend B and I want to owe the money to Jared. If the current interest rate is 4% and friend C wants to buy the 5% bond, he's going to get the payments of $50 a year. But he has to buy that bond for more than Jared paid for it. So he comes through and he says, Hey, Jared, I'm going to pay you $1,050. That'll pay off friend A's loan. And now friend A is going to pay me that $50 a year in interest. But I had to pay you more because your 5% bond has gone up in value. Interest rates have decreased. Now you get paid more for the bond if you sell it. And the inverse is true too. So right now we're expecting that the Fed will continue to cut rates. As interest rates decline, the bonds that you purchased beforehand will continue to appreciate in value. And then the inverse, this is what we went through in 2022. When interest rates were increasing, the value of the bonds was decreasing. 2022 was a really difficult year for bond investors. We saw the core bond holdings go down 12 to 15%. Yes, they started earning more in yield. But there, this is a great reminder that there is risk to principle. When you buy these bond funds, your investment can go down and it can go up. It's not as safe as a FDIC insured high yield savings account. It allows you to lock in that interest rate for a longer period of time. I think that's the takeaway is that while there could be some opportunity and it's maybe lower risk than some other things, generally speaking, that it's still not as liquid or as safe as actual cash in your high yield savings account. Let's focus to Muni's municipal bond funds. This is going to be really relevant for a lot of our physicians who are higher income earners. There's a real opportunity here to save or not to save, but really to maximize your return. So tell us a little bit about Muni bond funds. It's a good reminder that all of these interest payments, that's taxable income. So you have a high yield savings account that's paying you 4%. You got to pay taxes on that money. The house always wins. I say that a lot around here. The IRS always gets theirs one way or another in life or even in death. They will get paid. Touche. It is their game. We're just playing with it. That's right. They make the rules. So if I'm learning 4% of my high yield savings account, but I'm a physician, I earn multiple six figures. I live in a high state tax like New York or California or Connecticut. I could be paying 40 or 50% of marginal taxes on that interest that I'm receiving. Which a lot of physicians do. Taxes are a really big problem. Yeah. Especially when we see like joint households that are both physicians. It's not unreasonable for them to have a joint income of 500, $600,000 on the lower end, especially on a dual physician household. And that's in the highest federal tax brackets. When you file jointly, that's 37% federal taxes. If you're in California, you're paying another nine or 10% on top of that. New York, relatively similar, like seven or 8%. Maybe you live in New York city. You have a local tax. But when you add up all those taxes, it's like, all right, I earn 4% of my money, but I really only keep 2% of it because I have half of it goes to taxes. All of this interest income is on top of what I earn on my W-2 job or my practice or all of my earned income. So it does get taxed at the highest marginal brackets. So I lose half of my interest payment to taxes. What can I do about it? You mentioned municipal bonds. These are bonds that are rather than being issued by the federal government or by corporations, they are issued by state governments. By public interest projects like building bridges, building stadiums, building roads. And in exchange for you investing in public infrastructure and lending them that money. Yes, they'll pay you interest on your loan to them when you buy their bond. They also can be excluded from your federal income. And if you're buying a muni bond in the state that you live in, you can also exclude it from state income tax. What's the trade-off there? There's always, always a catch. The other shoe's going to drop. They pay much less in interest than a full taxable bond. So it's like, well, I could earn less, but I keep more of it. So what we really need to do is compare what do I get to keep? So kind of just looking at the return in both and then adjusting it for tax. Exactly. So that's a calculation we do all the time at SLP Wealth. And again, I'm going to put on my nerdy Fed Reserve Ben Bernanke glasses and call it tax equivalent yield. If I'm a physician in a high tax bracket, which bond am I going to keep the most interest after taxes? There's an equation that we do all the time to compare. How much do I keep on my high yield savings account? How much do I keep if I buy one of these bond funds that are taxable bonds? And how much do I keep if I buy a municipal bond fund? Furthermore, in the example of like a California physician, there are mutual funds that are specific to individual states. So there is a California municipal bond fund. There's a money market version. There's a short term version. Again, the yields are lower because you're saving a lot of taxes on it. You really just have to put pen to paper or in our case, keyboard to Excel sheet to figure out which one's going to be the best for you. Yeah, we're millennials. We don't use the pen and paper technique, although sometimes I still do actually. Old school can be. So takeaway from that then is that unlike the high yield savings account, it is not FDIC insured. It is an investment that can be subject to principal loss like any other investment. Yeah, but that can be a really big impact, especially for high earning physicians in the $300,000, $400,000 range or higher. You lose a lot of your interest income to taxes, and that's something that you really need to be considering is what's my net yield? How much do I actually keep? And there are alternatives out there. They pay less, but that's OK if you're a high earner. Great. Well, let's transition to number four, our fourth alternative T-bills. What are those? That's saying, hey, Uncle Sam, I'm going to give you some money. Can you pay me back? Treasury bills are a loan that you make to the Department of Treasury. It is backed by the full faith and credit of the United States government. It's a bond just like any other bond, except the lender is the U.S. Treasury. Because of that, historically, it's carried much less risk of default, like we talked about earlier, than like a corporate bond. I could go and take my $1,000 and lend it to Apple or Amazon or Caterpillar or some corporate company. And even though those are all robust companies that are very secure, companies can fail. Companies can not make whole their lenders. There's this notion that some companies are too big to fail. Yeah. And there's some grain of truth to that when we look at the great financial crisis. But there is always risk associated with any type of investing. What we're talking about here is fixed income investing. You're not buying equity share in their company. You're giving them a loan, and they're going to invest those dollars to grow their company. Treasury bills are loaning the money to the U.S. government. The U.S. government has not defaulted on U.S. Treasury debt in the past history. So when we read our certified financial planner books, they call this the, air quotes, risk-free rate. Compliance doesn't really like using the word risk-free. Called out. Yes, I am our compliance officer. We're not allowed to guarantee anything. I do like to say, though, with T-bills, really anything that is backed by the full faith and credit of the United States is that if there is a default, we are probably in some kind of like apocalyptic, like zombie eating scenario where you have bigger problems going on. You probably need to hide in your cellar and just eat your canned beans for a while. If you're investing in treasury bills, it's a very secure bond. It is not risk-free. There always is some level of risk. And they pay a little bit less interest than like a corporate bond. One really nice advantage of treasury bonds is if you are in one of those high state income tax states, US treasuries are subject to federal income tax, but they are not subject to state income tax. So again, we can put keyboard to Excel sheet and figure out which one's going to keep the most in your pocket. But treasuries are also issued over different maturity dates. This is what we've been talking about where high yield savings account have a maturity date of like one day. The bond funds, short term bond funds have a maturity date of two years or three years. You can buy a 10 year treasury. You can buy a two year treasury. You can buy a one month treasury. And when you buy that bond, you lock in that interest rate. You will get paid that coupon and you will get paid back your principal at the end of that maturity date. So treasuries are a great place to, to put money that you have a decent idea when you're going to need the money. If I know I'm going to buy a house in two years and I buy a two year treasury, it's like, all right, well, I know that I can earn 3.6% on this between now and then, regardless of what the interest rate market does. It's a good opportunity. And let's talk about our last alternative to the high yield savings account. It's, um, I'm going to call it a maturity focused bond fund. It's kind of a mouthful. There's like a brand name out there. You may have heard of like bullet shares. There's some other, you know, similar ones out there. But what is the deal with that? Because this is kind of new. Yeah. What could be more fun than a mouthful of financial jargon on a, isn't that like another day in the life? Yeah. Maturity focused bond fund. So things like treasury bills, individual corporate bonds that we've been talking about, um, those can require a lot of time and maintenance to like buy individual bonds. There's greater risk when you're buying individual corporate bonds in particular. And so there are mutual funds and ETFs that will purchase a big basket of all these bonds. They charge you a fee to do so. And this maturity focus bond fund will purchase a basket of bonds that all mature around the same time. So you could buy a 2026 maturity bond fund. And the goal of that manager is that all of the bonds will mature by. December 31st, 2026, at which point you get paid back the principle that you put in and the fund terminates. You do pay an expense ratio to the manager to do that legwork because it's kind of like a building a bond ladder. And that takes a lot of time. So this can again, be a great option. If you know, when you're going to need this money, if I know I'm going to buy a house in January, 2029, Hey, I could go buy a 2028 bond fund. And I'll know that I'll get some interest on it and I'll get my money back at the end of 2028. These are not FDIC insured. They're subject to investment risk. There are often corporate bonds in these funds, so you can experience principal loss with these. And then there's even within the maturity focus bond funds, you can buy a government debt, one, a corporate debt, one, or even municipal bonds, which we talked about previously. This is kind of a new option on the market. As Sim said before, read the fine print, but this could take a lot of the logistics of buying individual bonds off your plate. That's a really great overview. And so I guess to kind of bring it high level, right? Say I'm an investor and I want to buy a house. I don't know if I want to buy it in two years. I don't know if I want to buy it in five years. Where do I park my cash in that scenario? Cause I don't, I don't have a specific timeline. What do you, what would you tell someone Jared in that situation? The flexibility is worth something. There's a monetary value to having flexibility. What you want to avoid is closing doors for yourself. You want to have access to your money or liquidity when you need it. If you know for sure that you're not going to touch it for two years, then one of these maturity focused bond funds would be great. A T-bill for two years, treasury bill for two years would be great. If it's in a high yield savings account and you have a horizon of two to five years, that is the absolute safest, most flexible place where you're not going to lose principal. It's FDIC insured. The risk that you run for having money in a high yield savings account for a long period of time is that if interest rates decline, your high yield savings account might not keep up with inflation. So that a hundred thousand dollars that you put in for a down payment, uh, five years later, well, now your down payment's going to cost you 130,000 because prices rose. And that high yield savings account, that interest rate is going to fluctuate on a very regular basis. So some of these options that we're discussing today introduce the opportunity to hold onto the current high interest rate environment for a longer period of time. I think that's really important to note. It sounds like if you want to just keep things simple and keep it safe, maybe you'll end up sticking with your high yield savings account. There's opportunity to maximize rate in different ways, return, or, you know, your, your tax equivalent year yield, as we called it. That's something to consider. You always want to think about your personal risk tolerance, right? Because again, all investments are subject to principal loss. Can't you tell that I work in compliance? You want to think about your liquidity needs, how soon you might need all of that. When in doubt, I think it's always a great idea to talk to a third party, right? A fiduciary financial planner who can kind of help you figure out what your goals are, maybe nail down your timeline a little bit and talk through each of these options with you. Absolutely. And I couldn't think of a more, a more intriguing conversation for a September afternoon. I think Jared means that you guys, Jared loves this stuff. Yeah, I truly do. So if these topics kind of make your eyes glaze over a little bit and you're like, oh man, we've been talking finances for 25 minutes here. Well, first off, I hope we were super entertaining and we made this somewhat fun. Second out, you can work with someone who loves talking about this, that gets all excited about it. We spend all day thinking about these things and we have the credentials and the education behind it where we approach it from an academic perspective and really get to know you and your goals and can help you hash out what those timelines and those goals even look like. Yeah. At the end of the day, these are just products we use to get to where we want to be. So like buying a house or, you know, saving for our kids, college, whatever it is, right? It has to matter to you. So I think that is a great place to end. And as always, your net worth is not your self-worth. Take care, everyone. This podcast is for informational and educational purposes only and should not be considered individualized financial advice. If a specific investment is mentioned, it should not be considered a recommendation or endorsement to buy or sell the investment. You are encouraged to seek the advice of a financial professional before implementing any investment strategies discussed. All investments involve risk. Past performance does not guarantee future results.