For the first time in decades, savers are actually earning decent returns in 2023. Thanks to the Fed’s campaign of raising interest rates to combat inflation, yields on short-term, conservative income investments like CDs have soared.
But you may be able to earn even more by being active in your approach to your short-term investments. By prudently transferring money between different types of investments, you can maximize that passive income that you earn. While this requires some degree of effort on your part, it can be well worth it in terms of your increased income.
In order to fully understand the passive income strategy, it’s important to know the terminology involved in the types of investments you will use.
High-Yield Savings Account
A high-yield savings account is just what the name suggests: a savings account that pays a higher yield than a traditional bank account. High-yield savings accounts carry the same FDIC insurance as all regular savings accounts.
Certificate of Deposit (CD)
A certificate of deposit is like a savings account but with a maturity date. You’re not allowed to take your money out of your CD before it matures without paying a penalty. Like savings accounts, CDs carry FDIC insurance.
A no-penalty CD works just like a regular CD except that you can take your money out at any time. Usually, there is an initial waiting period of about seven days, but after that, you’re allowed to withdraw your money at any time.
Rates on no-penalty CDs may be higher or lower than what you can get on alternative options, depending on the issuer and various market factors.
U.S. Treasury Bills
U.S. Treasury Bills are securities issued by the federal government that are considered the safest investments available, as they are backed by the full faith and credit of the U.S. Treasury bills range in maturity from a few days to 52 weeks, and they are sold at a discount. As they approach maturity, they increase in value until they reach their face value and are paid out.
Essentially, this passive income strategy involves moving your money whenever possible to the type of account that pays you the highest yield. Of course, this only works if you have liquid money ready to spend — or if your money in another investment matures and pays off.
This strategy does not involve selling any investment to move the money to another.
Imagine you have your money in a three-month CD yielding 4.00%. The day it matures, you can look around at what current interest rates are on high-yield savings accounts, U.S. Treasury Bills and other CDs. Depending on your needs at the time, you’ll move that maturing money into the highest-paying instrument.
Note that a high-yield savings account is the most liquid of these three types of investments. Having your money in a HYSA allows you the flexibility to move your money instantly to any other higher-paying vehicle.
With Treasuries and CDs, however, there might be some restrictions or costs to sell your investment before it matures, so you want to try to avoid this as much as possible. Note that a no-penalty CD, in which you can generally take your money out after just seven days, can be another flexible option.
The bottom line is that to maximize your earnings, you want to chase the highest yields available before they disappear. However, you won’t want to tie up all your money either. For example, your emergency fund needs to be completely liquid, as you’ll likely need to access your money right away.
If you’re saving for a longer-term goal like the down payment for your house, however, you can usually afford to tuck that money away into CDs with three-, six-, or even 12-month maturities, as long as you’re getting a much higher yield.
While your money isn’t exactly “locked up” if you buy a Treasury or a CD, it’s not as liquid as if you keep it in a high-yield savings account. Selling a CD prematurely, for example, will usually trigger a penalty of a few months’ worth of interest. Selling a Treasury before it matures subjects you to the open market, where you may not get as much back as you have invested.
Something else to take note of if you follow this strategy is that some banks are better than others. For example, an online bank might offer you the highest yield, but if you want to be able to walk into a branch or talk with a customer service agent in person, this might not be possible.
Moving your money around to different accounts can also create a somewhat cumbersome paper trail. If you have accounts spread out at different institutions, you’ll receive numerous monthly statements and annual tax documents, which can be overwhelming for some individuals.
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