Optimizing Your Cash: Where to Put It
Prefer to listen rather than read? Pair this post with Deliberate Money Moves Podcast: Optimizing Your Cash: Where to Put It.
I’ve seen many people lose money in cash investments and it always happens the same way.
Searching for yield.
There are three important factors when it comes to holding cash: Liquidity, Risk of Loss, and Yield. If you are comparing alternatives and are only looking at yield, you will be giving up something in the other two areas of Liquidity and Risk of Loss.
The Importance of Liquidity: Accessing Your Funds
Liquidity is the ability to access your funds. Many people get tricked into putting their Emergency Fund into CDs. The problem here is that CDs have defined maturity dates and usually have a difficult process to access your funds even on the maturity date.
Your Emergency Fund is supposed to be available for an emergency, but if you’ve tied up your money in CDs, guess what? You no longer really have an emergency fund!
CDs can be useful tools, but remember, you give up liquidity when you buy CDs.
Evaluating the Risk of Loss: A Deeper Look at Treasury Bonds and Market Dynamics
Risk of Loss comes into play when there’s a possibility that your principal can disappear or be reduced. Many people think that buying Treasuries offers a guarantee on their principal, but that’s not really true.
Treasury bonds trade in the marketplace just like stocks and their prices move up and down. So, if you buy a Treasury bond today and then need to sell it tomorrow, you could end up selling it for less than you bought it.
It’s true that Treasuries are very liquid, but they present the possibility of loss should you need to sell them before their defined maturity date.
The Allure of Yield: Why It Captures Our Attention
Yield, of course, is important. However, we tend to focus too much on yield. I think this is probably because it’s the easiest factor we can use to compare investments.
For example, if CDs pay a higher yield than savings accounts, that’s something we can easily understand. But what we are missing, is the process for getting our money out of a CD on maturity date and perhaps the penalty we will have to pay if we want our money early. (We already know how easy it is to get money out of a savings account.)
So, where should we put our cash?
Smart Choices for Your Cash
Well, assuming by “cash” we mean that we cannot either give up liquidity or take on any risk of loss, then I recommend using either a high interest FDIC insured savings account or a government-backed money market mutual fund.
These strategies are offering yields of around 4 – 5% currently.
Evaluating the Worth of a Move
One other thought: If you are thinking about moving money to get more yield, be sure to calculate the dollar advantage and don’t just focus on the yield as a percentage.
For example, if you are thinking about moving $20,000 from your savings account currently paying 1% to another bank that is paying 4%, realize you are hoping to get only about $67 per month in extra interest (which is taxable, by the way). Then ask yourself whether it’s really worth it to make the move.