Cue opening credits…. Dark clouds gather over the famous Wall Street subway stop as various assets start falling all around – stocks, bonds, and real estate are crashing into the pavement while financial bears approach from every direction…There seems to be nowhere to hide! But wait, what’s that flying over the horizon? It’s Captain Cash and his trusty sidekick Yield to the rescue!
Ok, Marvel isn’t going to be buying a movie script from me anytime soon, but cash is making a major comeback and rewarding savers in a big way. Ray Dalio, the famous billionaire and founder of the world’s largest hedge fund, recently tweeted that he no longer thinks cash is trash.
Interest rates are rising everywhere from credit cards to auto loans to mortgages. For borrowers, this makes purchases much more expensive. However, for savers it creates an opportunity to start earning more yield (i.e. interest) on your savings.
It can be hard enough to meet everyday expenses, so the idea of saving isn’t always a high priority.With interest rates increasing, however, it is worthwhile reviewing both the “why” AND “how” of a thoughtful cash optimization plan.
The Importance of Savings:
“Emergency fund”, “rainy day fund”, and “dry powder” are just a few catch phrases that describe the importance of having a certain amount of accessible cash set aside. For every variable in our lives that we can control, there are countless others that we cannot. Unexpected expenses come up, income can be lost or reduced, and markets can (and will) crash and rebound. These variables present both challenges and opportunities, and that is where the benefit of having a cash savings strategy comes into play. Let’s review the basic principles of a smart cash strategy (see this earlier Common Cents article for detailed discussion on emergency funds.)
Emergency Fund Principles:
- Baseline: Keep 3 – 6 months of your necessary expenses in an easy-to-access savings account.
- Separate & Accessible: Your emergency fund should be kept separate from your everyday checking, but should be linked for easy access.
- Earn Interest: Use an FDIC-insured high-yield savings account.
Inflation & Rising Rates: Applying the Principles:
- High-Yield Savings: Ally Financial is currently paying 2.25% interest, and there are many other banks offering similar yields. As interest rates rise, the rate paid to savers in these accounts should rise also. Most of these banks were paying around 0.50% at the beginning of the year. I am looking at a 330% increase in yield this year alone! Do your homework and find the right bank for you.
- I Bonds: Government-issued bonds are just as safe as FDIC insured cash, and currently I Bonds are offering an annualized yield of 9.62%. Check out our Common Cents article last year and head to treasurydirect.gov for details and to open your account. There are important rules on holding periods and purchase limits. The chart below illustrates how much more interest you could earn on a current I Bond compared to a typical high yield account. This is a great place to keep excess cash or money that you know you will not need for at least one year, but don’t want to risk in the market. Please refer to the TreasuryDirect website or contact your Northbrook planner for more information and details on how interest is calculated for I Bonds.
- T-Bills: Similar to I Bonds, these are offered to savers by the US government and offer a range of yields based on the term of the T-Bill. Terms range from 4 weeks to one year. The average yield across T-Bills currently ranges between that of a high yield savings account and I Bonds. Strategies such as “T-Bill Ladders” can be very effective for managing some of your cash savings.
After taking inflation into account, growing a cash savings balance may actually be a losing investment when measured in real terms. However, in personal finance, the best returns are not always measured in dollars and cents. It is still important to make sure you have a decent cash cushion for emergencies, opportunities, or near term purchases. Allocating your cash to buckets that will keep it safe and earn interest becomes even more important in a rising interest rate environment.
A powerful but underemphasized point when discussing cash savings is having the ability to seize opportunities. Just like surprise expenses can come up, surprise opportunities to deploy cash can as well. Take the stock market drop we have experienced in 2022 – being in a position to “buy low” or maintain your dollar cost averaging strategy while stock prices are dropping is what defines a successful long-term investor. Opportunities and challenges will come, sometimes when you least expect them to: Life’s curveballs tend to work both ways. In the meantime, make sure your cash isn’t trash by maximizing its yield!
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The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
This content not reviewed by FINRA