Optimizing Return on Cash
This we all know: inflation is running high. And in the Federal Reserve’s attempts to bring inflation down to their 2.0% long term goal, they are raising interest rates, the consequences of which have slowly and finally made their way to consumer level accounts.
To be clear, keeping your cash in “safe” and “guaranteed” cash accounts like treasury bills and bonds, savings accounts, and CDs is still losing you value when inflation is higher than the interest rate you earn. On November 10, annual inflation as measured by the Consumer Price Index (CPI) was reported to be 7.7%.
If you are earning less than 7.7% on any of your assets, particularly your safe bank accounts, you are effectively LOSING MONEY SAFELY. The nominal value of your money is “safe”, it’s not going down. But what your dollars can buy, the value of your money, is consistently decreasing and has been since the beginning of 2021.
But that doesn’t mean there aren’t smart, good reasons for keeping a portion of your assets in guaranteed, liquid cash accounts. The top reason to keep cash is that it just makes sense to have some cash in case of the unexpected, which, let’s face it, happens a lot!
Call it an emergency reserve, a rainy day fund, or anything else, but keeping approximately 3 months of your necessary expenses in a liquid, guaranteed rate cash account is a great little insurance policy in this chaotic world. (But if you have more than 6 months of your necessary expenses, that may be costing you more than it’s worth).
Another smart reason to keep excess cash accounts might include knowing you want to make an asset purchase in the next 3-5 years and you don’t want your money to be subject to market risk. Many have real estate purchasing plans in the short term and know they’ll need cash. That’s smart!
Another valid reason to keep cash accounts is that the stock market causes you too much anxiety. You know you’ll sleep better to have the money “safe”, even if that means sacrificing purchasing power. (If that’s you, I encourage you to have a different conversation with someone you trust about where that fear is coming from).
So assuming you do have good reasons to keep cash, where should you be storing those cash assets to make sure you’re being a good steward of your money? Here’s the current playing field of options, but keep in mind, as quickly as interest rates are rising, this landscape has been changing very rapidly in the last 18 months.
All of these interest rates are as of November 10, 2022.
The highest guaranteed rate you can find right now is offered by the US Government in the form of I Bonds. They are currently paying 6.89% which you can lock in for 6 months. After 6 months the rate will reset based on inflation rates, which have been trending down in the last 7 months, but remain much higher than they were pre-pandemic.
Two major caveats to buying I Bonds:
You can only buy $10,000 per calendar year per Tax ID number. The work around to buy more than the $10k per person is to use trusts and LLCs, but that adds complexity. But it is viable. I’ve known couples to buy $60k of I Bonds in a calendar year.
There is no liquidity for 12 months, none. So don’t buy an I Bond unless you’re certain you won’t need the money for a year. However, in most circumstances, families have other options to fill short term cash needs but none are ideal, as they mostly involve credit, which always adds risk to a family’s plans.
You also have to consider the time and effort it takes to set up and manage your TreasuryDirect accounts (where you purchase your electronic bonds). Your time is valuable, and you certainly weren’t created to frustrate yourself for hours on a federal government website.
Another great option that has honestly not been a great option at any point in my adult life (same as with I Bonds) is Treasury Bills and Bonds. These interest rates are the closest thing to real time interest rates as it gets since they are the primary tool of the Federal Reserve for raising money.
You can buy Treasuries in a host of maturity schedules from as little as 4 weeks and as long as 10 years (although I would rarely recommend taking any maturity beyond 5 years). The real story in Treasuries right now is how high the short term (1-12 months) rates are, particularly when compared to what banks are offering.
You can see the current rates in this image:
I’d be very surprised if this doesn’t trounce what your local bank is currently offering for savings and CDs.
You can administer your purchases of Treasuries yourself in a brokerage account or directly with the Treasury on TreasuryDirect.com.
But I can also buy these for my clients if they have a brokerage account that I manage on their behalf, and TD Ameritrade gives us a lot of great tools to easily structure maturity ladders which can help with liquidity issues on the longer term maturities.
High Yield Savings Accounts
My favorite account to recommend for most of my career has been high yield savings or checking accounts at banks. I earned 2.5% for years in my personal high yield checking account in a small town bank (Union State Bank of Everest, KS) while inflation averaged 2% or less, effectively growing the purchasing power of my money.
Additionally, I kept a high yield savings account at Ally Bank which usually paid interest just south of what my checking account was paying, but almost always higher than CDs. Ally Bank (or CapitalOne 360, or Marcus, or Discover Savings) were accounts that I typically recommended to clients for the last 15 years because they were the simplest way to gain return on short term cash and savings.
But that has now changed as the interest rate landscape has morphed. These accounts are now running behind Treasury securities. However, that may not last forever. It could be a short term phenomenon. But you could lose out on a lot of interest if you “bank” on that and it doesn’t come to fruition.
I prefer to be more flexible with where I invest my family’s emergency and opportunity cash and once you have a few accounts established, it’s very easy to move money between accounts if you can keep good track of your login information. (But keep in mind, opening multiple accounts does add risk and increased management to your financial plan).
And thankfully, searching for more flexibility allowed me to come across an option that I can offer to my clients which allows me to do most of the administrative parts of managing savings accounts on their behalf and is currently paying 3.75%, FDIC-insured. It’s through a group called Flourish, which I actually vetted in 2019, but their rates weren’t competitive enough at that time. That’s now changed.
So what should you choose?
There is no way to know what the best fit is for you and your family because your situation and preference are uniquely yours. But you can know the landscape.
If you want a simple solution that I can help you with, I’m going to recommend the high yield savings account that I can help you manage. It’s straightforward and higher yielding than almost all other bank accounts. It’s FDIC insured and has high liquidity.
But if we truly want to optimize interest, we’ll need to consider if Treasury securities are the way to go.
What I know for sure is that your cash/savings levels are a very important part of your financial plan and I’m always ready to discuss what’s right for you and your family..