Excess cash can be a blessing and a curse. Stockpile too much of it in low-yield checking or savings accounts, and over time, you’ll end up eroding your net worth due to inflation. On the flip side, park your cash in fixed-income products, and you’ll generate higher, more consistent returns than what a checking account would offer, but at the cost of being unable to withdraw your money on your terms, among other risks.
In this article, we’ll explore the challenges of balancing liquidity, returns, and risk management when optimizing idle cash in personal financial planning. We’ll dive into various cash management strategies, their benefits and drawbacks, and how to align them with your financial goals. Additionally, we’ll discuss the tax implications and risks associated with these strategies, helping you make informed decisions.
Table of Contents:
- FDIC Limits, Multiple Banks Accounts, and IntraFi Networks Deposits
- High-Yield Checking and Savings Accounts
- Fixed Income: CDs, Bonds, and Laddering
- Tax Implications of Cash Management Strategies
- Risks of Cash Management Strategies
- Tailoring Cash Management to Your Financial Goals
FDIC Limits and Multiple Bank Accounts
Let’s start with some background information. The Federal Deposit Insurance Corporation (FDIC), a US Government agency, insures bank deposits up to $250,000 per person, depositor, bank, and ownership category. In other words, if you have more than $250,000 in a single bank, and that bank were to fail, you would not be insured for any cash exceeding the insurance limit. Which begs the question, what do you do with more than $250,000 in excess cash? The solution to this issue is to open multiple bank accounts. If you open another bank account at a different FDIC-insured institution, that account will also be insured for up to $250,000, essentially now providing you with up to $500,000 in coverage.
IntraFi Network Deposits
However, managing multiple bank accounts can take time and effort, especially depending on how much FDIC coverage you require. This is where IntraFi Network Deposits come in. IntraFi Network Deposits is a backend solution used by thousands of banks to allocate large customer deposits throughout an extensive network of IntraFi partner institutions. This service streamlines the process for individuals and businesses with deposits exceeding FDIC limits, enabling them to secure the coverage they need effortlessly. Presently, IntraFi Network Deposits offer a maximum FDIC coverage of $50 million. If you have a bank account with an IntraFi partner institution and hold a large amount of cash, ask your banker about accessing IntraFi Network Deposits.
High-Yield Checking and Savings Accounts
High-yield checking and savings accounts are FDIC-insured and are easy starting points for cash management. Banks are increasingly offering high-yield accounts to attract new customers, and there’s really no reason not to keep your everyday cash in a high-yield account. Generally speaking, the best high-yield accounts will be found at online-only banks, which can offer higher rates due to their lower overhead costs than brick-and-mortar banks. As of April 2023, rates on high-yield checking accounts can go as high as 5% with no account minimums.
In addition to traditional high-yield checking and savings accounts, cash management accounts have also been gaining popularity. These accounts attract customers due to their unique combination of checking, savings, and investment features, and you’ll likely have one if you open an account with a brokerage firm. Although cash management accounts do not carry FDIC insurance in the conventional sense, many are designed to offer FDIC protection for the cash stored within the account through sweep structures outlined earlier. It is crucial to thoroughly examine the terms and conditions of any cash management account to comprehend the account’s structure and the safeguards in place for your cash.
Fixed Income: CDs, Bonds, and Laddering
Another option to consider when managing idle cash are fixed-income products, such as certificates of deposit (CDs), bonds, and laddering strategies. Certain fixed-income investments offer relatively low-risk approaches to managing idle cash while providing investors with higher returns than high-yield checking and savings accounts.
US Treasury Savings Bonds
U.S. Treasury Savings Bonds (“T-bonds”) are a type of US government bond issued by the Department of the Treasury. These bonds are considered extremely low-risk investment options due to their backing by the US Government. Two types of T-bonds are currently available for purchase: Series EE Bonds and Series I Bonds. Both EE and I bonds earn fixed interest rates but differ in structure and purpose.
EE Bonds are “guaranteed to double in value in 20 years” and earn a fixed rate of return (2.10% as of April 2023). EE bonds can be purchased in any amount from $25 to $10,000, but there is a limit of $10,000 per calendar year. EE Bonds can be cashed in after one year, but cashing in any time sooner than the 5-year mark will trigger a penalty of 3 months’ interest.
I Bonds are designed to protect investors against inflation and earn both a fixed rate and a separate inflation-adjusted rate, which resets twice a year. I Bonds currently have an annual yield of 6.89% as of April 2023. Cash-in and purchase rules are the same for I Bonds as for EE Bonds.
Money Market Accounts
Money Market Accounts (MMAs) are FDIC-insured accounts offered by banks and credit unions that typically offer higher interest rates than traditional savings accounts. MMAs are FDIC-insured up to the $250,000 limit. MMAs generally have higher account minimums than a typical savings account, as well as monthly withdrawal limits. MMAs offer a strong alternative to traditional savings accounts, especially if preparing for a major purchase.
Money Market Funds, on the other hand, are investment vehicles that invest in short-term debt securities. While they may offer competitive returns compared to MMAs, they are not FDIC-insured and carry more risk, and it’s important to understand the difference between the two. For more information related to money market fund expenses, refer to each fund’s prospectus.
Certificates of Deposit
Certificates of Deposit (CDs) are FDIC-insured savings accounts offered by banks and credit unions and typically yield higher interest rates than traditional savings accounts. CDs require you to leave a fixed amount of money in your CD for a fixed period of time, ranging from a few months to several years, and in return, the bank pays you a fixed, above-average interest rate. If needed, you generally can withdraw money from a CD before its maturity date, albeit for a penalty. This flexibility gives CDs a short-term liquidity advantage over a T-Bond, which has a one-year lockup. CDs are also offered in shorter durations of less than one year, which can be helpful in planning for a major purchase.
What is Laddering?
Laddering is a strategy where investors split their money equally and invest in bonds or CDs with varying maturity dates to reduce risk and boost flexibility. By purchasing bonds and CDs with staggered maturities, investors can benefit from higher rates on long-term investments while maintaining liquidity. As each investment matures, the proceeds are reinvested into a new bond or CD with a longer maturity, forming a “ladder” of investments. This method balances risk and return while generating consistent income.
Tax Implications of Cash Management Strategies
When managing your cash through various strategies, it’s essential to consider the tax implications associated with each option. This section provides a brief overview of the tax implications for the cash management strategies mentioned in the article. For questions about your specific tax needs, speak with a Harness Tax Advisor or your tax professional today.
- US Treasury Savings Bonds: Interest on I Bonds and EE Bonds is subject to federal income tax. Exemptions apply if used for qualified higher education expenses or home improvements. Bonds are also subject to Alternative Minimum Tax (AMT).
- Certificates of Deposit and Laddering: Interest earned on CDs is subject to federal, state, and local income taxes and is taxed in the year the interest is credited, even if withdrawn later. Tax-free CDs may be available through tax-advantaged accounts like IRAs.
- High-Yield Checking and Savings Accounts: Interest earned is subject to federal, state, and local income taxes. Banks report interest payments of $10 or more to the IRS, and a Form 1099-INT will be provided to the customer.
- Money Market Accounts: Interest earned on MMAs is subject to federal, state, and local income taxes. Similar to high-yield checking and savings accounts, a Form 1099-INT is provided.
Risks of Cash Management Strategies
Understanding and managing the risks associated with your cash management strategy is crucial to protecting your assets and financial security. Some of the risks you may encounter include the following:
- Inflation risk: The purchasing power of your cash may be diminished by inflation over time. To counteract this risk, consider diversifying your investments with stocks or other assets, and not keeping too much of your total investable assets in cash management or fixed-income investments.
- Credit risk: Investments in fixed income, like bonds, come with the risk of the issuer defaulting on payment obligations. To reduce credit risk, opt for bonds with higher credit ratings, such as T-bonds.
- Interest rate risk: The value of fixed-income investments can be affected by fluctuations in interest rates. When interest rates increase, the value of existing bonds usually decreases. Implementing a ladder strategy, which entails buying bonds with staggered maturity dates, can help manage interest rate risk.
- Liquidity risk: Certain cash management investments might have lower liquidity than others. For instance, there could be penalties for withdrawing funds from a Certificate of Deposit (CD) before its maturity date. To prepare for emergencies or unforeseen expenses, keep a portion of your cash in readily accessible checking or savings accounts.
Tailoring Cash Management to Your Financial Goals
Your cash management strategy should be aligned with your financial goals, risk tolerance, and time horizon. Consider the following factors when designing your personal financial strategy:
- Emergency fund: Maintain a cash reserve for emergencies, typically 3-6 months’ worth of living expenses, in a highly liquid and easily accessible account, such as a high-yield savings account or a money market account.
- Short-term goals: If you have short-term financial goals (e.g., purchasing a car, or going on vacation), allocate funds to low-risk investments with a short time horizon, such as CDs or short-term bonds.
- Long-term goals: For long-term financial goals (e.g., retirement, education funding), consider a more aggressive investment strategy that balances cash with equities, bonds, and other assets to potentially generate higher returns.
- Risk tolerance: Your risk tolerance should inform your cash management strategy. If you are risk-averse, prioritize preserving your capital and opt for safer investments like CDs or high-quality bonds. If you are more comfortable with risk, explore investment options with higher potential returns.
By understanding the various cash management options available, the risks involved, and how to align your strategy with your financial goals, you can effectively manage your cash to optimize returns and protect your financial future.
How Harness Wealth Can Help
Managing idle cash effectively is crucial for striking the right balance between liquidity, security, and returns in your personal finance strategy. Harness Wealth can help you navigate these complexities by connecting you with experienced financial advisors who can tailor cash management strategies to your unique financial goals and circumstances. Don’t let your idle cash hold you back. Sign up for Harness Wealth today. Discover the full potential of your cash reserves with a personalized cash management and financial planning strategy tailored to meet your specific goals and needs.