Stashing Cash

Over the past several weeks we covered a handful of year-end considerations with the last being partly related to generating cash. In that post I mentioned how money market funds and bank CDs were great places to store cash. Let’s dig into that a bit this week. This is especially important because the short-term interest rate environment that drives this space is changing.

I tend to lapse into jargon when discussing these topics and some of that is unavoidable. My industry is complicated and there are multiple ways to say the same thing. One example is the use of the word “cash”.

Most of us think of cash as what we carry around but, in the financial services industry, cash also refers to investments deemed to be equivalent to cash. This means any federally-insured bank deposit product or other no-risk investment with a maturity of one year or less. So when we say cash we’re referring to money in your…

Checking, savings and money market accounts at your bank or credit union – that’s obvious.

Money market mutual funds and bank CDs bought within an investment account.

Individual US Treasury securities and maybe general obligation bonds issued by a state.

In other words, cash equivalents are the safe stuff, liquid and without market risk.

So in our example of last week you sold some investments to generate $20,000 to spend in the next year or so. You wanted to essentially eliminate risk on this money since you’ll have to spend it soon. That’s very prudent of you, but what should you do with the money in the meantime?

An easy answer is to deposit the cash into your checking or savings account but those accounts usually pay the least amount of interest. A quick review of a regional credit union’s website suggests they’ll pay a tenth of a percent on checking and savings balances. That’s not a good place for excess cash to linger.

The next best place to store cash would be a money market account at the same institution. These accounts typically have some access restrictions so you should get paid higher interest. The same credit union offers yields from 0.75% to maybe 3.5% or 4% at higher balances of $100,000 or more.

Remember that these percentages are annualized yields based on current rates and aren’t guaranteed. Money market rates fluctuate along with the short-term interest rate market and how aggressive the bank wants to be when gathering new deposits.

These rates were higher a month or so ago before the Federal Reserve lowered its short-term rate benchmark by half a percent. As I type the market is expecting about another 1.5% in rate reductions over the coming months so yields on cash should continue heading south.

But is that a terrible thing? After all, the money you keep at your bank or credit union is federally insured up to at least $250,000 and there’s no market risk. While not terrible, you can and should try to do better.

You could look at certificates of deposit at your current institution. The credit union I referenced above offers 4.75% annual percentage yield for CDs going out 6-8 months, perfect for short-term money. Go shorter and the rate drops. Perhaps ironically, the rate also drops if you go longer. A 12-month CD pays 4.25%, for example. Still, it’s safe money with a guaranteed rate for that length of time and is gettable before maturity if you’re willing to pay a penalty, usually a few months’ worth of interest.

Can you do better than that? In a word, yes, but it would mean opening a new account somewhere else. A quick review of “high-yield savings accounts” at www.bankrate.com shows FDIC-insured banks offering from 4% to over 5% on cash. Again, that’s not guaranteed for any length of time but the online banks referenced here are usually more aggressive than their traditional brick-and-mortar counterparts. You could also look at CD rates on this site and maybe go that route to address the time factor.

Instead, what I favor is leaving the cash in your investment account where you sold the investments (yes, my opinion is biased). There you can buy a money market mutual fund, CDs from a variety of FDIC-insured banks, or even individual Treasury securities. Link this account to your checking account and move money within a day or two. I think this setup offers more flexibility.

For example, here are some current rates you could find within an investment account, whether it’s a taxable brokerage, IRA, or even 401(k) with some custodians.

Schwab Value Advantage, ticker symbol SWVXX – This is a money market mutual fund designed to have a fixed $1 per share and pay monthly dividends that accrue daily. I use this frequently since Schwab is the custodian for most of my clients. The portfolio contains short-term government bonds, bank CDs, and other cash equivalents that, taken together, have an average weighted maturity of about 26 days. The fund had been paying around 5.2% but now pays about 4.7% because of the Fed change already mentioned.

Vanguard Federal Money Market, ticker symbol VMFXX – This is a popular money market fund at Vanguard that currently pays about 4.8% after recently paying more, same as with the Schwab fund. VMFXX has a weighted average maturity of about 30 days.

Fidelity and other brokerage firms often have their own version of these money market funds and most pay about the same as Schwab and Vanguard. Just watch out for fees and transaction charges at some firms (that shall remain nameless…)

Brokerage CDs – These are issued by FDIC-insured banks but bought through your investment account. I prefer CDs that go out to maybe 12 months, can’t be called away early, and that have a decent yield. I’m currently seeing about 4% or a little better for this timeframe. If you need to get out early you’d sell the CD on the open market within your account, sometimes at a slight gain but other times at a slight loss.

Individual Treasuries – US Treasury securities are among the most liquid investments available. Easily purchased in your investment account, you can also buy at www.treasurydirect.gov. As with brokerage CDs, you can choose a maturity period and rate combination that works best for your situation. Rates are a little higher as I type, maybe 4.3% for a 1yr bond. Again, watch out for transaction fees at some firms.

So there’s a summary of a few relatively simple options for holding cash. More exotic options come with various risks, costs, and strings attached so I avoid those like the plague. In short, keep your cash simple while trying to earn the highest rate reasonably possible. This is easily doable with a little legwork.

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