In our zero-interest-rate policy world, “Where do I put my cash?” is a frequently asked question.
According to Bankrate.com, average savings and money market accounts are yielding only 0.47%. That’s right…less than half a percent. Let’s compare that to inflation. According to the Cleveland Fed, their forecast for ten-year inflation calls for an average rate of 1.82%. This means cash investments in your average savings account or money market fund are going to lose around 1.35% of spending power every year. The Federal Reserve, and their partners in crime in Congress, decided long ago that they could get away with punishing savers and rewarding spenders. Cash accounts are used to provide liquidity to pay bills, meet immediate cash needs, and provide emergency funds covering up to 6 months in living expenses. So, the funds needed in this category could easily top $20K. Guess what? At that account value, that works out to losing $270 per year in spending power. Thanks a lot, Ms. Yellen.
We definitely need to do some things to improve our cash returns.
Before we consider better options, first let’s consider liquidity. If I own a stock index fund in an after-tax account, would you consider that liquid? Why can’t I just sell some shares if I need cash right away? For one thing, emergencies always seem to happen at the most inopportune times, like in the middle of a bear market. I could raise cash that way in a hurry, but it could hurt me a lot if I have to realize a big loss to get to my money. Even if I have a gain, I can be hit with capital gains taxes. Moreover, when I get around to re-purchasing the fund, I could be buying it back at a higher price, giving up the interim gains. I also have to be concerned about the wash sale rule. Therefore, with this in mind, our first rule about cash management is that liquid money means it is immediately available without restrictions or penalties. If I have held a 1-year Certificate of Deposit for three months, and it charges an interest penalty for early redemption, then it does not meet the rule. I have heard many argue the interest penalty is a reasonable cost for liquidity. There are far better alternatives, so why even consider that?
Let’s consider an investment that, although it has some restrictions, can be managed in a way that provides immediate access without penalty. I-Bonds. The restrictions are that they must be held at least one year, and there is an interest penalty if held less than five years. But, what if I can move some I-Bonds already held for five years within my bond allocation into my cash fund? Depending on the situation, I could do it in conjunction with rebalancing, or by replacing the older I-Bonds in the bond allocation with new ones. If they have been held five years (and they can be held for up to 30 years) they can be cashed immediately without penalty. Since I-Bonds are indexed for inflation, similar to TIPS, they will lose little purchasing power. (I say little instead of none because federal tax eats into some of the return.)
Another alternative is to set up a CD ladder with a CD maturing each month. If your monthly living expenses are $3,000, you might need around $36K versus around $20K for the I Bond strategy, and you will risk having an emergency that requires more than $3,000 immediately.
Why not just establish accounts providing immediate and unrestricted access to our money? At least, you will need a good interim measure if you need time to implement an I-Bond strategy. The best options are FDIC-insured savings accounts that provide funds access whenever needed. By doing a little searching, we can find quite a few options with rates higher than 0.47%. We need to get as close as possible to that 1.82% breakeven rate. Here are a few I found:
Santander Bank – extra20 checking pays $20 a month on balances of $1,500 and when you make two bill pay transactions per month. For an average balance of $2,000, that amounts to 12% per year, although $2,000 is probably far less than the total cash account value you are planning, and at that rate, I am doubtful this deal will be offered for long.
Consumers Credit Union – The best deal I found for larger balances is Consumers Credit Union, though it has some strict rules to earn the higher rates. The short explanation is you have to do 12 transactions per month on the debit card for 3.09% (ceiling is $10K), 12 transactions on the debit card and 12 transactions on the credit card for 4.09% (ceiling is $20K), and 12 transactions on the debit card and $1,000 of transactions on the credit card for 5.09% (ceiling is $20K). The rules are worth it if you typically use your cash at this level of activity. Here is a review of the deal from DepositAccounts.com. I suspect that, even if the deal does not stay around forever, they could continue to offer above average rates. They have a history of doing so, anyway.
Emigrant Bank. My Savings Direct provides a 1.25% rate with no strings attached, and no limits (other than the FDIC insurance limit of $250K per account, that is).
Mango and Union Plus had deals that provided 5% net of fees on up to $5,000 per social security number, but those are no longer available to new customers. For every option, be careful to check on how money can (or cannot) be moved out of the accounts, and of course fees related to moving money.
Remember that if you are carrying high interest consumer debt, as in higher than 3-4%, you already have the best “deal” …use your cash to pay it off.
While it is a challenge to keep up with inflation, a little effort can pay off when caring for your cash balances. If you are using no-interest accounts, it will pay you to make a change.