According to the Federal Reserve, cash balances of American households and businesses have jumped by $1.5 trillion since the end of February to a whopping $15.3 trillion. Cash is a haven in times of uncertainty or in anticipation of specific needs like tuition, vacations, or even unforeseen emergencies. Longer term goals like retirement are better addressed through investing in riskier assets, but money you need any time soon should be on the sidelines.
With all that cash sloshing around, one question frequently arises: “can I get a better return?” Answer: no. We inhabit an era of historically low interest rates, and it is important to remember that return and risk are intimately related. So while you should curb your expectations, here are a few tips to make the most out of a meager harvest.
It is important to define your time frame. Any savings expected to fund current obligations over the next year or two are probably best kept in the conventional instruments. If your needs are imminent, your checking account will do. Some banks pay a (very) low interest rate on checking, but the key here is safety and liquidity. No use fretting over a couple of bucks if you’re going to need it back soon.
Looking out a bit farther, you have options. Not good ones, but options nonetheless. CDs are FDIC-insured up to $250,000 per depositor, and now offer an array of maturities and terms. Contact your bank for current rates, or shop around on the internet. The downside here is the potential for forfeiture of some interest if you withdraw early, but today there many more flexible options available including no-penalty withdrawals (in exchange for a lower rate). You can build a “ladder” of varying maturities to balance higher yield against liquidity. But “higher” is strictly relative: current 1-year CD rates nationally average less than 0.5%, with some online banks as “high” as 1.3%. Whoopee.
Other options include high-yield savings accounts and insured money market accounts. Again, the best rates are available with online banks that have no physical branches, but even so, don’t expect much more than around 1.0% to 1.5% for your trouble. Remember that the object here is safety and availability.
If your need for the cash is less immediate (say 2-5 years out), there may be some other priorities to consider ahead of savings. Many of the estimated 40% of US households who carry a balance on high interest credit cards would be better served by knocking out that debt. Earning 1% on cash while forking out 22% in interest is a losing proposition.
Also consider reallocating more savings into your retirement plan, especially if you are not maximizing your employer’s matching contribution. It’s free money, and if worse comes to worst, most 401(k) plans have loan provisions (not recommended, but it may provide the psychological insurance to double down and get a bigger match).
If you have no high cost debt, consider a cash reward credit card for routine expenses. There are several low- or no-fee bank cards that offer anywhere from 1% to 5% cash back on your monthly purchases, depending upon the type and timing of your spending. If you routinely pay off the entire balance each month, this can equal or easily beat short-term investments like CDs. Check out NerdWallet.com or Bankrate.com for a comparison of cash-back cards.
With short term cash that you need to count on, accept the fact that that rates are low. Avoid the temptation to reach for yield (it’s not there anyway), and play it safe.
Christopher A. Hopkins, CFA