Until 2022, interest rates haven’t been much to write home about, but as rates start rising, you might wonder if your typical bank savings account is actually the best place to store your cash reserve.
Here are some ideas to keep your cash (safely) at work.
How Much Cash Do You Really Need?
To answer this question, you must consider the role cash plays in your portfolio.
For most, cash represents safety because it offers a cushion from market volatility, delivering protection during uncertainty. It also allows you to cover expenses without worrying about selling investments at a loss to pay the bills.
However, you don’t want too much of your savings sitting in cash. Why not? While cash is important, too much of it can stymie your growth and wealth-building opportunities.
It’s essential to strike a balance between devoting enough of your savings to return-generating investments and keeping enough in cash to protect your wealth. So how much is that?
Many people benefit from parking about 3-6 months’ worth of spending in cash, plus enough to cover short-term goals like year-end travel and emergencies.
For the past few years, with interest rates so low, that meant leaving cash in a checking or savings account. But with interest rates rising, a traditional checking account may no longer be the best place for your money. Where should you store it now?
There are numerous low-risk vehicles to consider depending on your needs and goals.
Check Out A High-Yield Savings Account
Yes, it might be time to break up with your bank that’s only paying 0.2% on your savings account. Today, there are so many more (higher-paying) fish in the sea and banking options available.
Several online banks, like Ally, offer upwards of 2% for savings accounts. While that might not sound like much, it’s still a 10x increase from what you had previously.
You don’t give up much flexibility to make the switch, either. High-yield savings accounts are liquid and accessible, making them a suitable place to keep your short-term cash needs. They are also federally insured, like your traditional savings account, so you don’t have to worry about losing your deposit.
Shop around and compare just like you would for any other financial service or product. When looking for banks, try to avoid as many “strings” as possible. Different banks will have different requirements regarding account minimums and the number of withdrawals you can make within a certain period.
Consider A Money Market Fund
Money market funds are a solid next step for cash savings that you need to maintain access to.
Don’t confuse money market funds with money market accounts, which are bank products. A money market fund is a type of mutual fund made entirely of short-term fixed-income investments.
By purchasing a money market fund, you can invest in safer instruments like Treasury bills, municipal bonds, or corporate debt. Sometimes a fund may combine each type for diversification or exclusively invest in one category.
Money market funds can be a good fit for the portion of your cash you want to earn interest but still maintain safety. Most money market funds will attempt to keep a stable net asset value of $1.00 while providing a competitive yield.
If You Can Wait For Your Money, Look Into I Bonds and CDs
Depending on how much liquidity you need, especially in the short term, I bonds may be a good option.
Even if you aren’t completely sure what they are, you’ve probably heard of them because they have taken over the financial news over the last few months. That’s primarily due to their safety (the U.S Government backs them) and their inflation-adjusted interest rate.
With historical inflation over the last year, it’s no surprise they’ve been so popular.
How I Bonds Work
I bonds consist of both a fixed rate and a variable rate. The fixed rate is set when the bond is issued and doesn’t change until the bond matures or you cash it in.
The variable component of the interest rate adjusts for inflation every six months. Each November and May, the treasury announces the new inflation component depending on the value of the CPI-U.
There is considerable confusion about when your bond actually adjusts for the new rate. The value of the variable component in force at the time you purchase your I bond is the rate you’ll get for 6 months, regardless of when you purchase the bond. At the end of that 6 months, you’ll get the next announced rate.
There are a couple of unique I bond characteristics you need to be aware of as they may impact your decision to purchase them.
- First, you are limited to how much you can buy in a given year. Each individual is limited to purchasing:
- $10k in electronic bonds through the Treasury website.
- $5k in paper bonds available through your tax return.
- You also can’t redeem your I bond within the first 12 months of purchase. If you redeem within 5 years, you will forfeit the last 3 months of interest.
It’s also important to understand how the interest payment on an I bond works. Unlike traditional corporate bonds or the similar Treasury Inflation-Protected Securities (TIPS), I bonds don’t make regular interest “coupon” payments. Instead, the interest is added to the principal amount of your bond, and you get it all when the bond matures or you redeem it.
I bonds are a safe way to help your cash keep pace with inflation. Realistically, keeping pace with inflation is often the goal of short-term money anyway, so this is a way to ensure that you do. You can hold an I bond for as long as 30 years if you decide not to redeem it before then.
Consider a CD
Another avenue to consider is a bank certificate of deposit (CD).
CDs are financial products sold by banks that mimic a savings account. This account earns a set interest for a limited time on a lump sum. So you could engage in a CD that locks in $10,000 for 5 years and pays a guaranteed 3.5% interest rate. If you withdraw the money sooner, you break the agreement and become subject to penalties and fees.
You’ll want to shop around to find the best rate for the specific maturity you need. Maturities can vary from one to several years, so select the maturity that works best for you.
Are You Holding Cash That Isn't Protected?
Cash is cash, right? Not quite. Especially if you’re talking about significant quantities.
With cash, you want to ensure you can access it when needed. That would make the virtual wallets or other “virtual” accounts convenient because you can transfer money on demand and often instantly.
But many online accounts like Cash app, Paypal, and Venmo aren’t federally insured. If you’re storing cash in these types of accounts, consider additional avenues that offer better protection.
If you like one of these services and perhaps use the app regularly because it’s simple, consider keeping a smaller balance in the account and moving the rest to a more traditional account that offers FDIC protection.
Is Your Cash Plan Effective?
Cash may seem simple, but you don’t need to overlook its role in your financial plan. The right cash plan can keep the rest of your strategy running smoothly.
Call us today to discuss ways to improve your cash management process.