Managing Your Cash

You may have recently received an inheritance or annual bonus at work and now have a little extra money in the bank, and are wondering what to do with it. Consider having cash an excellent “problem” to have, and be aware of the possible options for holding cash besides a savings account.

First, you should identify your short-term needs and financial goals. Some people may be saving for a down payment on a house or building their emergency fund. For specific purposes like these, accessibility and liquidity can be the most important things to consider when determining where to store your cash. Still, the yield or interest rate you earn on the money can also be a factor, so it is helpful to understand how the different factors impact where to place your cash.

Based on these considerations, you should determine which of the available options would work best for your situation. Below is a list of some possible choices for managing your cash.

Checking Account : a deposit account which typically allows unlimited withdrawals and deposits while offering the convenience of accessing funds using checks, ATMs, debit cards, and electronic payment apps such as Venmo.  This type of account is suitable for immediate cash needs and frequent transactions; however, checking accounts typically offer the lowest yield of various options for holding cash.

Savings Account : a deposit account that usually earns a higher yield than a checking account; however, the number of monthly transfers and withdrawals may be subject to strict limitations. This type of account can be a good option for emergency savings or “rainy day fund”. Financial planning professionals typically suggest keeping six months of required living expenses in cash, preferably in a savings account because of its accessibility.

High Yield Savings Account : many online banks offer interest rates that can be significantly higher than comparable savings account from a “brick and mortar” bank. A typical downside of using an online bank is not having the convenience of having money at the same institution as your checking account. Online accounts typically do not offer checks or debit cards; however, an online savings account can be linked to a checking account at another bank to transfer funds between accounts. This type of account is suitable for cash that will not be needed in the next six months or longer to accumulate the additional interest that you would not get if it were in a typical savings account. Uses could include saving for a down payment on a house or car.

Certificate of Deposit (CD) : a deposit that is different from a savings account because it has a fixed term and interest rate. Usually, longer CD maturities have a higher interest rate, and you can forfeit some of the interest as a penalty if you withdraw money before the end of the CD term. After opening a CD, you usually cannot make additional deposits into that CD; therefore, it is common to ladder the CDs, meaning you purchase CDs with varying maturities. This type of account is suitable for planned purchases or payments (such as a large payment that you are expecting in six months) for people who have excess cash reserves on top of their “rainy day fund”. CDs can be a place to set aside money that you do not want to touch until a defined future date, as it accrues interest and can offer a way to mitigate potential volatility risk of other investments.

Money Market Account: similar to savings accounts; however, money market accounts usually pay higher interest and allow checks and debit cards. They are more restrictive than a typical savings account and typically require a minimum account balance, limited transactions, and fees. This type of account is suitable for someone who can meet the minimum balance requirements and prefers more yield without the restrictions of a CD.

Money Market Mutual Fund : a mutual fund that usually invests in highly liquid, short-term investments such as US Treasury bills and commercial paper that have a high credit rating. These funds can offer high liquidity with a low level of risk based on the type of underlying securities held in the fund. It is essential to understand that Money Market Mutual Funds are not FDIC insured. This type of account is suitable for temporarily parking cash, and as a holding position in an investment account before investing elsewhere. Money market mutual funds can offer the opportunity to earn a small yield while waiting for new investment opportunities to arise. Keeping extra cash accessible can be beneficial when the economy may be approaching a downturn by providing stability during those times and a source of funds for opportunistic investments without having to sell other investments.

Short-Term Bonds : bonds with maturities ranging from a few months to five years. You can choose between US Treasuries, municipal, and corporate bonds. The US government issues Treasury notes, so they do not have the potential default risk that corporate bonds do. It is important to note that the market value of fixed-rate bonds will vary as interest rates change, meaning if interest rates go up, the current market price will fall. Since short-term bonds can fluctuate in value more than other cash alternatives, you should consider owning these bonds until maturity. If you have more than $250,000 in cash (the FDIC coverage limit for deposit accounts), you may want to consider US T-bills because they are considered the safest of all investments. Municipal bonds are attractive to high-income earners as the interest is not subject to federal income tax.

Short-Term Bond Fund: a mutual fund that pools together investors’ money to buy various bonds to diversify the credit risk found in investing in one company or municipality. Since mutual funds have expenses paid by the fund, it reduces the income the investor will receive compared to owning individual bonds. This type of account is suitable for those seeking long-term income with the liquidity that individual bonds do not provide.

Conclusion

Not only should you determine which combination of the previously mentioned cash accounts aligns best with your needs and goals, but you also need to decide what the right amount of cash is for you when looking at your overall portfolio. Keep in mind that holding large amounts in cash typically loses the race against inflation and misses out on the potential gains that the stock market offers. If you need guidance with your financial situation and choosing a blend of cash and investments that work best for you, reach out to a qualified financial professional who can help.

Disclosure: The information provided in this article is for general educational purposes and not intended to represent tax, legal, or accounting advice. Individuals should discuss their unique circumstances with qualified professionals in these areas before making any decisions.