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In this series Empirical advisors answer common questions about financial planning and investing as an individual. If you have a question for our advisors, please leave your name and question in the comment section at the bottom of this article.

How should I manage large amounts of cash outside of my investment portfolio?

At Empirical we advise investors keep safe, liquid cash outside of the portfolio designated for longer term objectives.  It is typical advice to have between three to six months (in some cases a year) of living expenses in a savings or money market type account.  These funds are kept on hand for periodic spending or emergencies.  Depending on the amount of money, and how immediate the need for that money might be, there are various modes of storage for this emergency “cash” that might be ideal.

In today’s low interest rate environment it is reasonable to pose the question: “What should I do with my cash to generate a reasonable rate of return?”

Our answer, talk with your advisor and revisit two questions: How much do I currently need as a cash reserve and how quickly will I need access to it?  It is important to get answers to these questions before you make any changes to the way you are investing your cash reserve.  Maybe you have more cash than you need sitting on the sidelines and the surplus should be deployed to your longer term objectives.  Maybe you have less than you need so an approach needs to be designed to increase your cash reserves in the most efficient way.  Further, in response to the second question, there may be a reason that you won’t need immediate (daily) access to the entire cash reserve at once. A longer holding period may open up additional investment options for your reserve money. Taking a moment to perform this important exercise should yield better results than simply comparing cash returns.

After addressing the first question, if the amount of money you want to hold is fairly small, less than $10,000 or so, the best option is probably to use a bank savings account.  The return is negligible (usually less than 0.1% a year), but the money is essentially instantly available, and the principal isn’t large enough to where the small return is particularly harmful.

If the amount of money is greater than $10,000, then it is time to consider the next question.  If a need from the money arose, how soon would you have to have it?  If you would need the money within a day or two, the best savings vehicle would likely be a money market account, or MMA.  At present, the rates of return on an MMA can range from 0.5% (for an investment of less than $10,000) up to 1% (for investments over $50,000).  There are also several savings accounts that offer returns of at or around 1% annually, though often times these accounts require a minimum initial deposit and continuing balance to keep those rates.  The website www.bankrate.com is one excellent source for current rates of return on savings accounts and MMAs.

If the need to get cash is slightly less urgent, another strategy could be to create a laddered portfolio using certificates of deposit (CDs).  CDs are essentially miniature bonds with maturities ranging from 1 month to 5 years.  They are riskless (insured by the FDIC) and somewhat liquid, so they generally can be sold in a hurry if necessary.  Depending on the construction of the CD portfolio, the return can be higher than that of a MMA.  For example, a CD ladder created using CDs with maturities of 3, 6, 9, and 12 months is currently yielding about 0.77% annually.  Similarly, a short term fund of highly rated bonds can provide a well-diversified investment with a higher yield than a typical savings account or MMA.

Before making a final decision on any new account or investment product, first consider if the change in return is worth the time it would take to change savings vehicles.  For example, if the new savings strategy is only going to earn you an extra $10 a year, it may not be worth it to make the change.  The following table gives several examples of annual and semi-annual yields under different interest rates.

 

Account Balance:

$25,000.00  

Daily Compounding

Interest Rates

Savings Rate

Earned 6 months

Earned 1 year

Savings

0.10%

$12.50

$25.01

Savings

0.25%

$31.27

$62.58

Savings

0.50%

$62.58

$125.31

Savings

0.75%

$93.93

$188.20

Savings

1.00%

$125.31

$251.25

Savings

1.10%

$137.88

$276.51

Savings

1.25%

$156.74

$314.46

 

Account Balance:

$100,000.00  

Daily Compounding

Interest Rates

Savings Rate

Earned 6 months

Earned 1 year

Savings

0.10%

$50.01

$100.05

Savings

0.25%

$125.08

$250.31

Savings

0.50%

$250.31

$501.25

Savings

0.75%

$375.70

$752.81

Savings

1.00%

$501.25

$1,005.00

Savings

1.10%

$551.51

$1,106.06

Savings

1.25%

$626.95

$1,257.82

 

Further, it is important to read the fine print when looking at institutions offering “above market rates”.  Often times they will advertise teaser rates that last for a short time only after setting up an account.  If there is no stated time period they are likely able to change the rate at any time.  The goal is to get you in the door and hope you won’t go through the hassle of changing banks after the teaser rate disappears.  Be very cautious about the investment arms of banking institutions presenting you with riskier investments as a way to increase your cash reserves.  This is an apples-to-oranges situation that often presents you with all the risk while the institution receives some form of commission/fee incentive. If you have any questions about the best way to store your money, or on how to invest in any of the above mentioned products, your Empirical financial advisor would be happy to help.

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About Kenneth R. Smith

Ken is the Chief Executive Officer of Empirical Wealth Management. He holds an M.S. in financial analysis and is a Certified Financial Planner®.

Discuss: “How should I manage large amounts of cash outside of my investment portfolio?”

  1. January 3, 2013 at 8:39 pm #

    Thank you very much for this informative post. It gave me a better idea on how to look at my options when it comes to investing my hard earned money. Bank savings no longer appeal to me because of the very small interest rate applied. The value of money is reduced when the rate of inflation is considered. Add to this is there is also a witholding tax charged by the government so ordinary savings is definitely not for me.

    Posted by BleacherViews

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