Sitting on Too Much Cash? Critically Assessing Your Emergency Fund Needs
After a decade of low interest rates, there are now multiple options to get a good return on your cash.
If considering a high-yielding savings account, make sure to comply with FDIC-insured limit of $250,000 in any single account ($500,000 for joint accounts).
For high-income earners, it is important to consider tax implications when deciding where to keep your cash.
With everyone worried about the safety of their bank deposits, and with many institutional banks still paying meager interest rates, why do people still have large piles of cash sitting in their bank? It could be for a number of reasons. Maybe they are unaware that they could be getting much higher yields on checking, savings and money markets elsewhere. Or perhaps they’re convinced it’s too much of a headache to open new accounts at another bank and to transfer lots of money just to get a few extra percentage points in interest. Or sometimes it’s because they don’t understand the difference between CDs, Treasuries, savings accounts and money markets and which of these are most liquid. Let's tackle these one by one.
How much ready cash do I need?
Every situation is different. At Novi, we first consider your lifestyle expenses. Second, we consider what your near-term goals. Are you planning a down payment on a house, car, or boat? Are you funding a wedding, an around-the-world trip, or a major tuition payment? We want to ensure you have enough cash available to finance those big expenditures without having to deal with potential volatility in the stock market.
For clients that are still working, it is recommend that they keep some money in an emergency fund. The emergency fund acts as a stop-gap for unexpected large expenses or potential job loss. A good rule of thumb is to keep least three to six months’ worth of living expenses in a liquid cash account. This amount varies for each person and we will work with you to determine how much is a proper amount for you to retain in an emergency fund.
If you’re retired and relying on your investments and income to cover your ongoing expenses you have less of a need for an emergency account. Instead, we want to ensure that there is always somewhere to raise cash from - whether this be from selling stocks or selling bonds. However, we do like to keep some cash in all clients' accounts so that they are able to achieve their short-term needs. Over long periods of time, it is expected that stocks and bonds will outperform cash equivalents. So it is important to not sit on too much cash (even though the current rates do appear quite attractive).
And a quick tip for business owners - if you own a business and need over $250,000 in liquid cash for ongoing business expenses, then it may be worth spreading that money out among three or four banks so you never have more than the FDIC-insured limit of $250,000 in any single bank. The extra administrative challenge of having multiple bank accounts is worth it to be 100% protected by the full faith and credit of the U.S. government.
Whether you are a business owner or have recently experienced a windfall and need somewhere to put your cash for the short-term, there are now services that make it easier to manage multiple bank accounts. Companies such as Flourish Cash or MaxMyInterest (Max) are aggregators of bank savings accounts across the U.S. Both of these companies partner with banks offering the highest yields and allows you to spread your cash across accounts at multiple banks while keeping your balances below the FDIC insurance limits. In addition to those benefits, it’s very quick and easy to access your cash if needed.
CDs vs Treasuries vs High Yield Savings vs. Money Market
So you've established an emergency fund - where is the best place to store your cash now that you can actually get some decent return? Each of these instruments mentioned above are pretty safe as long as you’re structuring them properly. Treasuries are protected by the full faith and credit of the U.S. government. CDs and savings accounts are covered by the FDIC (up to $250,000). And money markets, while not always covered by FDIC insurance, can provide a high return and easy way to access cash. They’re all relatively safe and pay roughly the same interest rate. So, it all comes down to liquidity – i.e., how easy it is for you to access your money. Money markets, savings accounts, and Treasuries are all relatively liquid. You can get your money out within 24 to 48 hours. But with CDs, there’s often an early withdrawal penalty for taking out your money before the CD reaches maturity. So, we tend to favor Treasuries, Money Markets and High Yield Savings over CDs for most clients.
For each client, we assess your situation to determine where best to store cash. It is important to keep in mind that all four options mentioned above will be taxed at the federal level. However, treasuries have the added benefit of not being taxed at the state level. So if you are a high-income earner or live in a state that has a high income tax structure, it may make more sense to invest in treasuries. Even if they are paying less than some of the other options. This is something we will work with all of our clients to determine the best course of action.
Conclusion If you or someone close to you has concerns about having too much (or too little) cash on hand -- or where to park it --please don't hesitate to reach out. We’ve helped many clients like you in similar situations.
RYAN A. DUNN, CFP®, is a Wealth Manager at Novi Wealth.