Last week, somebody asked:
Is there a better way to get a return on short term savings? I just did my taxes and the interest I thought I made on my emergency fund was basically cut in half by California & the IRS.
Contrary to popular belief, the savings account—a childhood staple in American life—may not be the best place to save money. Let me explain why.
Savings account interest is taxed as income by both federal and state governments. You’re never going to see the rate your bank advertised. That slick online savings offering 2.25% nets you just 1.35% if you live in SF/LA/NYC/etc and make a moderately high income—as many of you reading this seem to based on google analytics.
There’s tax-advantaged alternatives for short term savings or emergency funds:
The “risk free” option
Short-term treasury bonds. By law, US government bonds are exempt from state income tax. The yield on 3-month “risk-free” treasuries is about 2.5% (yearly) right now. So you can buy a short-term treasury ETF like Vanguard’s VGSH and easily beat any savings acct. Like most ETFs, VGSH is extremely liquid, giving you the ability to pull your money out any day the market is open. Just like your savings account, treasuries are backed by the faith and credit of the US government. If 3-month treasuries ever dropped 50% like the stock market does, trust me when I say your FDIC-insured savings would also be in peril.
The better but added risk option
Municipal or “muni” bonds are exempt from federal taxes and can be exempt from state taxes. Vanguard’s municipal bond fund, VTEB, also yields 2.5% right now. But due to tax benefits, it pays more than any savings account or equivalent treasury bond—you’ll net close to the whole 2.5%. You can even buy California or NY-specific ETFs that will be 100% tax free.
The added risk comes from the fact that you’re now loaning money to local state governments (mostly in New York, California, and Texas). In the bond world we call this added credit risk. Unlike a savings account, VTEB has daily volatility. However, VTEB holds mostly AAA and AA rated bonds—nothing like stock market risk. Going back to the financial crisis, your worst drop would’ve been -9%, but finishing down only -3% for the year.
The even higher risk option
Don’t mind the risk of a loss potentially over double that (but still want less risk than the stock market)? This makes for less of an emergency fund, but as the law of finance states, more risk = more return. The next step is “high yield” municipal bonds. Same tax free benefit, but can double the yield of the others. An ETF option for this would be HYD, which yields 4.25% currently. Tax-wise, it’d be like your bank offering 7%.
For return like this you’re taking on even more credit risk and term risk (loans for longer periods of time are more sensitive to interest rate changes). Instead of giving your money to AAA borrowers, you’re giving it to BBB and below borrowers like the Chicago board of education and the NJ transit authority. Still diversified over thousands of bonds however if done via ETF; easy to pull your money out when the market is open; and fairly uncorrelated to the stock market.
(Disclosure: I’ve owned all three mentioned; VGSH, VTEB and HYD. Also this is not investment or tax advice. Please consult a registered advisor, someone like Bernie Madoff prior to 2008.) ■
…is the amount Amazon paid in federal income taxes last year. Same as in 2017. Not only that, but they’ll receive roughly 150 million in refunds, making their effective tax rate actually -1% on 11 billion in profits. Amazon isn’t the only company who will be profitable and pay no taxes for last year, but they will get the brunt of the bad PR due to their recent NYC debacle.
Whether this is bad or normal, is extremely complicated of course. It has to do with how capital investment is expensed. Just know that, if you own an index fund (or have a pension or 401k), you’re profiting from this. Light up that cigar, you fat cat.
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