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At Betterment, we think a lot about how people manage their unused cash. After all, unused cash is often the money you could be using to pursue your financial goals through investing, but instead, you’re keeping it liquid. We know from talking to our customers that holding cash isn’t always intentional; it’s a choice by default—not knowing how, when, or why to put your money to work.
So, when we talk about unused cash, it doesn’t look the same for every investor; it’s simply the money that you haven’t yet spent and you haven’t yet invested for a purpose. As your advisor, our ultimate recommendation is for you to identify the purpose of that money and to plan to save and invest for future expenditures. Until you identify that purpose, our advice for managing unused cash aims to achieve several priorities:
- Protect the principal balance
- Generate as much yield as possible to mitigate inflation (keeping costs low)
- Retain liquidity—i.e. access to the money—without penalty or extraneous restrictions
A starting point for evaluating cash savings products is to first make sure your principal balance is well protected, looking for ultra low-risk solutions. From there, evaluate expected yields, opting for a high yield relative to available options. Next, consider any minimum deposit amounts, fees, penalties, and tax consequences of the cash savings product. And finally, evaluate any product-specific risks.
Here, we’ll compare Smart Saver with other products using this approach. As you’ll see, no one solution offers ideal principal protection, yield, and liquidity. However, understanding the tradeoffs can help you make smart choices about managing your unused cash.
Evaluate Yield: Smart Saver vs. Savings Accounts
A historical convention for many Americans is to maintain unused cash in a savings account at a bank (or credit union) earning interest; often with the hope of combating inflation. Because of their widespread use, savings accounts are a likely comparison for individuals evaluating Smart Saver in place of a cash savings product.
Among savings accounts, rates in the form of annual percentage yield (APY) are set by the bank based on the margins earned on money the bank loans out and the bank’s business circumstances. In contrast, Smart Saver’s expected yield rate (a composite 30-Day SEC Yield) is based on the recent dividends, interest and expenses from ultra low-risk, short-term bonds that the cash is invested in. Learn more about how the yield is calculated in our methodology for Smart Saver’s underlying investments. Both a savings account’s APY and Smart Saver’s expected yield approximate how much income a deposit could generate in a year, but there are important differences in how the numbers are determined, which should affect your degree of confidence in whether the expected yield will match the actual yield. Of course, historical performance, even very recent historical performance like the most recent 30 days of yield, is not an absolute indicator of future performance.
In the case of a savings account, APY is a pre-defined number, rather than a calculated one. Working within the margin earned from loaning your money out, banks can raise or lower their accounts’ APY to attract new business. This can even occur within a year. A bank might raise rates to attract new customers, or lower rates to manage business operations. In addition, a bank can reset the structure of their yields based on deposit size.
In contrast, Smart Saver’s yield, a composite of 30-Day SEC yields for the portfolio’s underlying bond funds (net of fund fees and Betterment’s 0.25% management fee), are set by the market and cannot be adjusted by Betterment (unless Betterment changes its management fee). Smart Saver is structured to generate a yield that correlates to federal interest rate changes, as the underlying bonds are sensitive to federal interest rates. The assumption underlying the 30-Day SEC yield expectation is that each bond in the funds will be held to maturity. In reality, the bond funds underlying Smart Saver are not held to maturity, as to enable liquid access to your money, but they have historically had ultra low price volatility and relatively low turnover, leading to our expectation that the 30-Day SEC yield is a fair estimate of future yield.
While banks’ rates for loaning money are also sensitive to federal interest rates, they have some discretion for how much of the margin they pass to savings account holders in increased interest. Hence, when evaluating the average savings account APY in recent history, most bank APY rates have not risen as quickly as national metrics like the Federal Funds Rate.
As shown in Figure 1, we can assess what the typical savings account APY looks like using the Federal Deposit Insurance Corporation’s “Weekly National Rate,” a simple average of rates paid by U.S. depository institutions (which does not include credit unions, but does include any bank’s branch-specific rates). We use the rate for deposits below $100,000. As of Nov. 1, 2018, the Weekly National Rate is 0.09%. Access the FDIC’s weekly update.
As a simple average, you should know that FDIC National Weekly Rate does not account for each institution’s total assets under management or number of customers, and thus, it may not reflect the actual savings account APY that customers are receiving in the marketplace. However, given that customers do not have access to all possible rates, it’s a reasonable definition of the typical savings account APY available in the United States. The highest yields are often well above the FDIC rate, so it may also be worth comparing Smart Saver to a select group of higher-yield savings accounts.
Hypothetical Historical Performance:
Smart Saver vs. the Average Savings Account
In this chart, we compare Smart Saver versus the Average Savings Account in relation to national interest rates, illustrated by the Fed Funds.
The above chart shows the hypothetical growth of $10,000 deposited in Smart Saver, as if the account was available starting in 2016, which we use as the marker for the recent period of rising federal interest rates. The chart shows Smart Saver’s hypothetical performance (using data from Xignite), net of fund fees and Betterment’s 0.25% management fee. This backtest of performance assumes daily rebalancing and reinvestment of all yields. Both “Fed Funds” and the “Average savings account” represent theoretical accounts. In the case of “Fed Funds,” it’s not possible to invest in the Federal Funds Rate; this chart illustrates account growth if it were possible, using the national interest rate. The average savings account also represents a hypothetical savings account based on the average of savings accounts nationwide. The source for both “Fed Funds” and “Average Savings Account” is the Federal Reserve.
Similar to this chart, Betterment provides a comparison between the weekly national rate and the expected yield for Smart Saver as a fair benchmark of potential yield for Smart Saver customers. At present, this comparison shows that Smart Saver’s expected yield of 2.23% is about 20 times the FDIC Weekly National Rate. We update this comparison on a quarterly basis, using the FDIC National Weekly Rate and Smart Saver yield.
The key learnings from this comparison are that the typical savings account has a much lower yield than Smart Saver, and also has a yield that tends to lag actual interest rate changes, which profits the bank assigning these yields at their customers’ expense.
Protect the Deposit: Smart Saver vs. Bank Accounts
When considering how well protected your cash deposit is in any account, many customers will again turn to the products banks offer, including savings accounts, checking accounts, money market accounts, and CDs. Some customers may also compare Smart Saver to products such as a cash management account or a debit account, depending on their desire to spend the deposit into the future.
We recommend considering several variables when evaluating the safety of any amount of unused cash:
- The risks involved in what kind of institution you use to hold your money
- The risks involved in how an institution uses your money
- Any insurance that applies to the account
To start, your choice of institution matters for how safe a deposit is. Putting money in a bank involves different risks than brokerages, which involve different risks than financial advisors. It’s worth noting, of course, that all of these options’ cash savings products typically involve less risk than holding on to cash outside of an account. For example, a bank has a regulated responsibility to protect your money, but banks are not typically required by regulation to have a holistic fiduciary responsibility to provide you with advice in your best interest. Similarly, depositing your money with a broker-dealer (even one tied to a financial advisor) involves different risks than putting your money with a bank. A bank account balance may be insured, while an account balance at a broker-dealer rarely is.
Any institution could become insolvent, in which case, the risk to your money largely depends on how the institution has used the money. In the case of bank savings accounts, deposits are loaned to other customers, which means that in the case of bank insolvency, your money is in use elsewhere. (For this main reason, banks are covered by FDIC insurance, which we explore in depth below.)
With Smart Saver and some kinds of money market accounts, your money is put in underlying investments that seek to generate yield. In the case of the firm’s insolvency (i.e., the firm holding your investments), your money would then still be invested in the underlying vehicles.
Cash savings may be protected to varying degrees by certain types of insurance coverage, depending on the type of firm. Because banks loan money out to other individuals and entities, their deposits are generally insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. This includes savings accounts, most money market accounts, and CDs. Accounts at Betterment are not FDIC insured. Broker-dealers, including Betterment Securities (which provides brokerage services to clients of Betterment), are required to be members of the Securities Investor Protection Corporation (SIPC), which provides up to $500,000 in protection for securities customers of its members if the member faces insolvency. However, SIPC insurance does not protect changes in the value of those deposits, or in the case of fraudulent changes to an account. For details, visit SIPC.
Keep Money Accessible: Smart Saver vs. Money Market Accounts and CDs
Once you’ve assessed the potential yield and level of protection in potential cash savings products, you’ll likely find that a pattern emerges between how accessible your money is and the other two variables we’ve explained. In particular, some products can provide premium yield in exchange for little to no access to your money for a given period of time—most often years.
The paramount example of how you can seek higher yields for less liquidity is a certificate of deposit (CD) at a bank. CDs may offer high yields for extremely low risk, but in exchange, the certificate holder agrees not to withdraw the deposit for the term of the certificate. If customers do withdraw from CDs, they are usually subject to high penalties.
An important feature of Smart Saver is the ability to access any amount of your cash, without penalty, while still seeking a high yield. While there are CDs with higher yields than the expected yield of Smart Saver, they usually come with terms that far exceed the amount of time we would suggest leaving cash unused. Most high-yield CD terms are only advisable for those customers who are extremely averse to taking on any level of risk over a period of time.
A less extreme example than CDs are money market accounts and some savings accounts that restrict the number of transactions you can make in or out of the account. If you plan to use your unused cash in a variety of ways, then a restrictive number of transactions in and out of the account may pose a challenge to you. Similar to CDs, making more than the allotted number of transactions can lead to penalties.
Since Smart Saver pursues its yield by investing your money in ultra low-risk funds, access to withdrawals is not limited to a certain number of transactions. Rather, the main limitation is the amount of time it takes to process a withdrawal. In the case of moving your unused cash into goal-oriented investments, this process simply requires trading into the proper allocation, which can happen within the same day. To withdraw money for cash spending, it takes approximately 4-5 days to sell out of the funds and electronically move your money to a linked transaction account.
Smart Saver is one of many available cash savings solutions. Know the tradeoffs.
In this paper, we outlined the importance of evaluating cash savings solutions based on their ability to protect the principal balance, generate as much yield as possible, and help you retain access to your money. As you consider Smart Saver and other products, you can review the acceptable reasons Betterment customers might use Smart Saver, as well as how we developed Smart Saver’s underlying portfolio. As with any financial product, we encourage you to explore the tradeoffs of Smart Saver, ask us questions, and decide whether it’s the right solution for you.
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