If there's one thing so far that's kinda rocked my world of financial thinking as an MBA student, it's the idea of short term investments as a freelancer or small business. Investing always seemed like something you do only for retirement, but as we started learning to read and analyze business financial statements, I kept seeing a line for short term investments.
I'll say this upfront and very directly: I'm not an accountant, tax professional, or financial advisor. I learned a long time ago to work with financial professionals whose responsibility is to help me with my business and personal finances. Anything I'm sharing related to money is based on my personal experience and what I'm currently learning in the course of my MBA program. If you've followed me for any length of time you should be sick of me taking about this nonsense, but alas, here we are.
If you're self-employed and anything like me, you normally pile up some cash throughout the year to pay your known and scheduled expenses (taxes, business insurance, life insurance, etc), right?
I've been doing the full-time freelance thing since 2011 and from the beginning I've been putting aside a regular percentage of my profits from each project. When we were living in New York City, I was setting aside 30% for taxes, but we're in Oklahoma now and our taxes are much lower. Currently I'm putting aside 20% for taxes and 10% for retirement. That's worked out for me over the years and is something I'll continue to do until I have a reason to do otherwise.
Another part of my income is my stock footage licensing via Filmsupply. Those payouts fluctuate, but my monthly averages normally cover my overhead costs: salary, car payment, insurance, utilities, etc. I don't have regular expenses directly associated with those licensing fees, so I'll set aside 20% for taxes and 10% for retirement off the top, then allocate the remainder to cover my monthly overhead and stash the rest if and when there's more.
My taxes are typically paid at the end of the year and I've got a couple other major business expenses I save for and pay once a year. In the meantime, that cash being set aside to cover those expenses is just parked in a basic savings account. It's not my emergency fund, but if necessary I can use that small pile as a cash buffer when work is slow or clients are taking their dear sweet time to pay invoices. When work does pick up and I've got extra cash, I make sure to refill that fund. Remember, that cash is specifically set aside to cover those short-term (less than one year) major expenses as mentioned, but surely it could be more productive before its intended purpose months down the road (i.e., short-term investments).
Basic Savings Account
Until recently, I thought I was being smart by parking that dedicated money in a savings account. Here I am, letting the bank use my cash in exchange for the interest rate they're paying me. Well, if you're paying attention, you'll realize the bank isn't really out to make you money. They're a business too and more interested in making their own money and using your cash to do so.
According to the FDIC, as of Dec. 19, 2022, the typical savings account in the U.S. earns 0.3% interest annually. Keep in mind that 0.3% annual rate gets divided over twelve months, so it's actually 0.025% each month.
\[{0.3\% \, annual \,rate \over 12 \,months}= .025\% \,per \,month\] \[\] \[principal * \left( {annual \,rate \over 12 \,months} \right)^{number \,of \,periods} = earned \, interest \] \[$1,000 * \left( {0.3\% \over 12} \right)^ = \$0.25 \] \[\] \[$1,000 + \$0.25 = \$1,000.25 \]
Basically, if you park $1,000 in a savings account this month at 0.3%, next month you'll have $1,000.25. Your $1,000 earned a whopping $.25 in interest. It's not nothing, but yea it is.
High-Yield Online Savings Accounts
There are those high-yield online savings accounts and I've got freelancer buddies who swear by them for their parked cash. Right now, the best interest rate I could find in a high-yield online savings account was 4.13%. Going back to that $1,000 we'd talked about earlier, let's say you put it in one of those high-yield savings accounts this month. What does it look like next month?
\[$1,000 * { \left( 4.13\% \over 12 \,months \right)}^ = \$3.44\] \[\] \[$1,000 + \$3.44 = $1,003.44\]
By simply moving your money into an account with a higher interest rate, your $1,000 made enough in interest that month to buy you a decent cup of coffee. You're not getting rich by any means, but the interest you'd earn is much better than what you'd get with a regular savings account.
Short-Term Bonds
A bond is a promissory note issued by a business or a governmental unit when they want to raise additional money. Basically, a bond is a loan for an agreed upon period of time that makes additional money for the lender while the borrower is using it. Then at the end of the period, the borrower pays back the full amount they borrowed.
Bonds can get crazy complicated, but I'm intentionally trying to keep things simple. Specifically for this blog post, I'm going to stick with U.S. Treasury Bills (T-Bills), which are short-term bonds and range from four to 52-weeks. Because these U.S. Treasuries are fully backed by the U.S. government, they're considered to be nearly risk free and are one of the safest investments in the world.
These T-Bills are known as zero-coupon bonds and they're sold at a discount from their par value, meaning the actual purchase price is less than the bond's face value. Your return (profit) is the difference between the face value you get back at the end of the period (maturity) and what you actually paid to get it. For simplicity, let's assume we purchase a $1,000 zero-coupon bond at a 10% annual rate that'll mature in 52 weeks:
\[Purchase \,Price = {Maturity \over (1+annual \,rate)^{number \,of \,periods} } \] \[Purchase \,Price = {$1,000 \over (1+10\%)^ \] \[Purchase \,Price = \$909.09 \] \[\] \[Return = Face \,Value - Purchase \,Price \] \[Return = $1,000 - \$909.09 \] \[Return = \$90.91 \]
We're in this weird spot at the moment where the rates on these short-term T-Bills are crazy high. I could nerd out with you about the time value of money and inverted yield curves, but that's not my purpose here. Just know these nearly risk-free short-term investments are available with unusually high interest rates. As I'm writing this at the end of December 2022, the eight and 13-week T-bill rates are 4.3% compared to this time in December 2021 when those same bonds were at 0.05% and 0.06% respectively.
Let's go back to that $1,000 we'd talked about earlier. So instead of putting that money into an online savings account at 4.13%, let's say we buy an eight week T-bill at 4.3%. The math gets more complicated here and it's much easier to use a spreadsheet or financial calculator. The spreadsheet formula below allows you to calculate present value, basically the current value of that $1,000 face-value bond we're talking about.
\[= pv (rate, nper, pmt, fv, type) \] \[= pv \left( {4.3\% \over (52/8)}, 1, 0, -1000, 0 \right) \] \[= \$993.43 \] \[\] \[Return = Face \,Value - Purchase \,Price \] \[Return = $1,000 - \$993.43 \] \[Return = $6.57 \]
Keep in mind that $1,000 is a bit harder to get to than if it was simply in a savings account, but remember it's intentionally set aside to cover planned expenses later in the year. It's basically locked up for the length of time you committed to. Also, keep in mind the T-Bill example I gave is for an eight-week period. To make it a fair comparison with the basic savings account at 0.3% annual interest and those high-yield online savings accounts at 4.13%, you'd need to compare the interest earned over two months.
\[ \text{Basic Savings Account: 0.3% Annual Rate (Two Months)} \] \[ \$1,000 \times \left( \frac{0.3\%}{12} \right) = \$0.50 \] \[ \$1,000 + \$0.50 = \$1,000.50 \] \[ \text{Return} = \$0.50 \] \[ \] \[ \text{High Yield Savings Account: 4.13% Annual Rate (Two Months)} \] \[ \$1,000 \times \left( \frac{4.13\%}{12} \right) = \$6.90 \] \[ \$1,000 + \$6.90 = \$1,006.90 \] \[ \text{Return} = \$6.90 \] \[ \] \[ \text{8 Week T-Bill: 4.30% Annual Rate} \] \[ = \text{pv}\left( \frac{4.3\%}{(52/8)}, 1, 0, -1000 \right) \] \[ \$1,000 - \$993.43 = \$6.57 \] \[ \text{Return} = \$6.57 \]
What I've started doing recently is purchasing these short-term T-Bills directly from the U.S. Treasury via treasurydirect.gov. You'll have to set up an account and all that nonsense, but it's free and not that hard to do. A quick Google search can get you help in walking through the process, but I'd point you towards this Forbes article on How to Invest in Treasury Bills.
Also, I've been using $1,000 as an example, but the minimum investment for these T-Bills is $100, so I've been buying them in $100 and $200 chunks every couple weeks as the money I'm setting aside has been coming in. There's whole other conversation we could have about scheduling these short-term investments to land before your planned expenses, reinvesting after the T-Bill matures, and bond laddering, but that's not my purpose here. That said, I'm down to nerd out if you are.
The Stock Market
That nonsense is a dumpster fire at the moment. Not saying to completely stay out of the stock market, but I'm assuming you like to not lose money and have short-term plans for that money you've got stashed. Stocks are much more volatile than the boring bonds and savings accounts I'm gushing over, but historically stock market returns are much better. The S&P 500 – a basic benchmark for the U.S. stock market overall – has averaged an 11.88% yearly return since its inception. That said, the S&P 500 dropped nearly 20% in 2022.
Cryptocurrency
No. Just no. Personally I think crypto is interesting and I've got a small amount in a couple different things. Still, it's the freakin' Wild West out there and you're actually going to need that money we're talking about for your planned expenses.
So What's Your Point?
I'm over here singing the praises of these short-term bonds (T-Bills), but the high-yield savings account at 4.13% example I'm using is actually giving a better return. I'd consider each one equally safe seeing as how those savings accounts I linked to are backed by the FDIC and T-Bills are backed by the U.S. government. There's even some checking account options that'll earn you better returns, but you've got to watch out for minimum balances, ATM fees, and other expenses.
My point is to do something with that stashed short-term (less than one year) money that'll earn you more interest than just letting it sit in a 0.3% savings account. For sure too there's a conversation related to the tax obligation connected to the interest earned (capital gains), but for most people it's no higher than 15%. Paying attention to what your money is doing and the interest rates available may take a bit of leg work, but personally I think it's worth it. I'm keeping an eye on these T-Bill rates considering how high they are at the moment. That said, a high-yield savings account seems pretty low maintenance, but honestly I'd rather not deal with setting up another bank account. When you buy T-Bills, the funds are pulled and deposited directly into the bank account(s) you setup with your treasurydirect.gov account.
I'm sure I'll revisit these ideas throughout the year and I'll let you know how things shake out. By all means, if you're in a similar situation with your financial nonsense and have a tip (you can back up with legit evidence), I'm all ears.