Where’s the best place to keep your cash now that rates are rising?
Insights from our cash management expert
With short-term interest rates on the rise – up nearly 35% from one year ago1 – is it time to find a new place to park your cash that offers a higher rate?
Source: Board of Governors of the Federal Reserve System
It’s certainly worth taking a look, especially if you’ve been inclined to neglect your cash savings over the last decade of low interest rates. As you do, don’t forget that the interest you’ll earn isn’t the only factor to consider when you stash your cash. Even if another vehicle pays a little more, will it meet your objectives for easy, timely access and safety without too many restrictions or fees?
What’s your objective? Begin with the end in mind.
Finding the right cash vehicle starts with knowing what you intend to do with the money. For example, if the money comes from the sale of real estate and you are planning to purchase more real estate in the next few months, you’ll want to keep that cash relatively liquid, but still earn a little while you wait.
On the other hand, if that money is earmarked for a slightly longer-term need (to pay property taxes, for instance), you may choose a different vehicle. In this case, a certificate of deposit (CD) that pays higher interest, but may have charges for early withdrawals, could be the right choice.
Your objectives will determine how quickly and frequently you need access to your money, and how much risk you’re willing to take with the principal. And those factors, in turn, will determine which investment choices are most appropriate.
While the higher rate environment certainly makes people reconsider how they’ve been investing their cash over the past decade, the first step, before you start looking at what vehicles to choose, is to think through what your objectives are. Understand what buckets you are trying to fill and what you are planning to use the cash for before you start looking at your investment options.
At the same time, it's important to make your decisions about cash management and investing in the context of your overall financial picture.
Apply a business-like decision framework
Parker believes the same framework and principles that he and his Boston Private colleagues regularly use to help corporate clients strategically manage their cash can apply to individuals as well. “Our views come from the standpoint of working with the treasurers, controllers, and CFOs of a variety of companies, where the conversations begin with questions about their cash flow needs,” he explains. “We might ask: ‘What was your cash flow activity over the past year or two?’ and ‘What is your forecast for cash needs for the next 12 to 24 months—and which assumptions in that forecast are most at risk?’”
They then recommend solutions to meet each client’s objectives for Daily Operating Cash, Core Cash, and Strategic Cash, as illustrated below.
Cash Solutions to Meet Your Objective
Here’s how Parker suggests using similar categories of objectives to evaluate your cash situation with your advisor and find the best solutions.
1. Cash needed to cover daily operating expenses.
This is the money you’ll need over the next few months (fewer than 90 days) to cover the day-to-day living expenses for your household. It’s roughly equivalent to the cash a business needs to cover its daily operating expenses.
Potential solution: An FDIC-insured bank checking or NOW account (preferably one that pays interest) is probably the best option to get the access, flexibility and safety of principal you’ll need for the cash that covers your everyday needs. If it’s linked to a savings account or money-market deposit account at the same bank (see #2 below), you’ll also have a way to earn a little extra interest on your cash before you transfer it to checking.
Just remember, even as rates rise, checking accounts won’t pay much interest beyond what they currently do. And there may be fees to pay if you don’t keep a minimum amount in the account or you exceed a certain number of transactions.
2. A core cash position for your shorter-term investments.
This category of cash includes your regularly occurring income and cash flows. “For a corporation, these are recurring cash flows that you expect to see coming into the pipeline over 60 to 90 days. For individuals, this core cash of ‘receivables’ is basically your steady, reliable income,” says Parker.
This is also an area where he suggests working closely with your financial advisor to analyze your income over the past few years and anticipate where there might be “dips or peaks.”
“You can work with your advisor to smooth out the peaks by establishing an automatic investment program that allocates a certain amount from your core money market, savings, or ICS® account into your day-to-day operating account,” Parker says. That can give you the opportunity to earn some incremental interest on the money before it moves to checking. Just be aware that such transfers can take two or three days to complete.
Potential solutions: Consider putting the cash you’ll set aside for your core cash position into short-term vehicles that pay slightly higher interest rates than checking accounts, but are still FDIC-insured such as money market deposit accounts, a high-yield bank savings account, or an Insured Cash Sweep account (ICS®) now offered by many banks.
The drawbacks: While all three types of accounts are insured, they typically are “bare bones” accounts with limited check writing or ATM access. They may also require that you maintain a minimum balance and/or limit the number of transactions you make each month to avoid additional fees.
3. Strategic cash positions to meet longer-term needs or irregular cash flows.
The strategic cash position “bucket” includes cash that you want to invest for a longer term and cash that you receive infrequently, such as an annual bonus. This would also include the cash you hold in your investment portfolio, which is typically about 5-10% of your total asset allocation.
Potential solutions: You have a number of options for investing your strategic cash, as described below.
Money market mutual funds
Available from brokerage firms, money market mutual funds invest in highly liquid, safe securities such as certificates of deposit, government securities, and commercial paper (short-term obligations issued by corporations). Although they are not FDIC-insured, they are covered by SIPC insurance if they are held in a brokerage account. And they generally perform better than their money market deposit account counterparts. You also can write checks or use an ATM for quick access to your money.
Certificates of deposit (CDs) and CD ladders
CDs are sold primarily by banks, with maturity dates running from three months to five years. Depending on its maturity, a CD may pay more interest than a money market vehicle. If offered by a bank, it also will be FDIC-insured. The only drawback: Your money isn’t available until the CD matures. If you must redeem it early, you'll pay a penalty.
CDARS® (CD Account Registry Service) securities
CDARS® are a relatively new type of CD investment available through member banks to give corporations and high net worth investors a way to invest more than $250,000 in CDs without losing FDIC insurance coverage. But that protection comes with a lower return rate than a traditional CD.
- Although safer, they do not always provide a better return than money market vehicles, CDs, and shorter-term corporate bonds. (That’s why it’s important to compare current rates.)
- Also, you may forfeit a portion of your original investment if you withdraw your cash early.
Municipal “muni” bonds
Municipal bonds are issued by state and local governments to raise funds to build schools, highways, and other projects that benefit the community. Because the interest income they pay is exempt from federal taxes (and may be exempt from state and local taxes if you live in the issuing municipality), munis are desirable for high-income investors looking for ways to reduce income tax liability. On the flip side:
- You will usually pay a commission to buy municipal bonds.
- If you need your money before the muni matures, you may not get all of your investment back.
Short-term corporate bonds and bond funds
Corporate bonds represent debt issued by companies and usually pay more interest than government securities, money markets, and CDs because you are taking on more risk. Those risks include:
- The probability that the company that issued the bond could run into difficulty and stop interest payments – or even cease to exist.
- The likelihood that if you withdraw your money before the bond matures, you may not get all of your original investment back.
The most creditworthy companies will pay less interest on their bonds and the least creditworthy will pay more, based on industry ratings of their ability to meet their debt obligations. Of course, only short-term bonds are appropriate for your short-term cash needs.
If you purchase a short-term bond mutual fund, its NAV (net asset value) will fluctuate because of interest rate movements and trading of the bonds in and out of the fund. So, there is no guarantee that your original investment will be available when it’s time to take your cash out. You may have to pay a commission or “load” to initially purchase shares and extra fees if you withdraw your money too soon. You also will pay a portion of the fund’s expenses each year that you own it.
Consider all the factors beyond interest rates
As this review of potential vehicles suggests, there are many other considerations to take into account in addition to the amount of interest your cash will earn, such as:
- Principal risk: Will you lose a portion of your initial investment if you need access to your money quickly and are forced to sell an investment before it matures or recoups short-term losses?
- Safety: Will the money be there when you need it? If it’s FDIC-insured, the answer is “Yes.”
- Liquidity risk: Is your ability to use or move your money restricted in any way? Will you pay penalties for taking money out early?
- Minimums: Some cash options have higher minimums to open an account than others. Will that make your choice unavailable?
- Access: How easy is it to quickly obtain your cash via an ATM, check, phone call, or electronic funds transfer (EFT)? Will you have access to your money on your mobile device or online?
How Boston Private Can Help
In the end, the discussion with your financial advisor about where to invest your cash now should focus on your objectives – why you are setting the cash aside, how soon you’ll need it, and how safe you want it to be – not just on the effect of rising interest rates. Your advisor can also help you evaluate any changes you make to your cash positions in light of your overall investment strategy and financial plan.
If you haven’t planned to have that discussion with your advisor yet, now might be a good time to get it scheduled … before the Fed announces another rate hike.
1 - 10-year Treasury Summary at https://ycharts.com/indicators/10_year_treasury_rate
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