How do I find the best risk-free interest rate for investments?
March 02, 2016
Q: Please tell me where I can get the tax-free account with safe maximum interest rates?
A: As simple as that question may seem, it actually breaks down into three components:
- Setting up a tax-advantaged vehicle
- Defining safety
- Finding the highest interest rates
Here are these three components in depth:
1. Set up an investment vehicle with tax advantages
The best way to approach the tax question is to set up a tax-advantaged vehicle like an individual retirement account (IRA). These allow for a variety of investment products to be used within them, giving you the latitude to choose the product that suits your risk profile and has competitive rates.
Traditional or Roth IRA for tax-free savings?
Within IRAs, you can choose between a traditional and a Roth IRA. The principle difference between the two is that a traditional IRA allows you to defer taxes until you start taking money out of the plan. A Roth IRA requires that you pay taxes up front, but then all your investment earnings and distributions from the account are tax-free.
A major factor in deciding which IRA is right for you is whether you think your tax bracket is likely to be higher now or when you are in retirement. When you are in a relatively low bracket, you can pick the type of IRA that will require you to pay taxes.
As you might gather, these plans are not completely tax free, but they do offer you the opportunity to defer taxes or avoid taxes on investment earnings.
2. Determine which investments are 'safe'
Though several investment products and instruments offer guarantees of principal and interest, the key is to determine who is backing that guarantee. For example, an insurance annuity product may only be as safe as the creditworthiness of the company issuing it.
Are government-backed deposits safe?
Generally, to be completely safe, people opt for investments backed by the U.S. government. This includes Treasury bonds and FDIC-insured deposit accounts.
However, time frame is also a factor. Treasury bonds can fluctuate in value up until the time they mature, so if you have a shorter time frame, this may represent some risk.
Certificates of deposit (CDs) don't fluctuate in value, but if you need to access your money before maturity you may face a penalty. Again, time frame is a factor in determining what "risk-free" means.
3. Locate the highest interest rates
Once you have determined the risk profile and the time frame that suit you, you can compare rates among products with similar characteristics.
How can you compare interest rates?
For Treasury bonds, this is pretty straightforward - Treasuries with similar maturity dates should have similar yields. For deposit products, you have a wide range of choices and bank rates for savings accounts and CDs vary widely.
As you can probably guess, it helps to get the question of how you want to define safe investments out of the way before you start comparing interest rates. That definition will narrow down the field, and allow you to make apples-to-apples comparisons of rates among vehicles with essentially the same risk profile.
Find the best offers and make it easy to find the right low-risk investments for you via the deposits listings provided by MoneyRates.