We’ve been getting lots of questions lately on where to invest cash and other short-term reserves for upcoming anticipated needs. One of the silver linings of a rising interest rate environment is that you have more options on where to invest your liquid assets.
Let’s start with the basics first. You should consider investing your money in buckets based on the time you have to invest and the level of risk you are willing to take with each bucket.
The first bucket is your emergency reserve, and the general rule of thumb in financial planning is to have an emergency reserve worth 3-6 months of living expenses. This bucket of money needs to be liquid and easy to access should something unexpected happen in your life (job loss, natural disaster, major car repair, medical bill, etc.). This prevents you from having to take out a loan or sell investments at an inopportune time and causes you an unexpected and unwanted tax impact.
The next bucket is cash you anticipate needing within the next couple of years, maybe for a large purchase or anticipated change in income. Similar to your emergency bucket, you want this to be relatively liquid and easy to access.
Money Market Accounts and Funds
Money market accounts can be opened and held at either a bank or credit union, and you can usually find the best rates for these accounts before opening one on sites such as DepositAccounts.com and Bankrate.com. Make sure your money market account is FDIC or National Credit Union Association insured. These accounts also often have check writing privileges as a feature for quick access to funds when you need them.
Separate from money market accounts, you can also purchase money market mutual funds at investment companies such as Schwab, Fidelity, and Vanguard in your investment account. These are not insured by FDIC, but many of them only invest in securities issued by the U.S. Treasury or an agency of the U.S. government so are usually just as safe. For our clients, we often purchase a money market fund in their investment account at any of these institutions. When the funds are needed, we sell out of the fund and cash is available the following business day.
High-yield savings accounts
These accounts are offered at banks and credit unions, are backed by the FDIC or NCUA, and are similar to money market accounts except they do not have check writing capabilities. You can also search for the best rates on high yield savings accounts on the two previously mentioned websites.
Certificates of deposit or CDs
A CD is a deposit at a bank or credit union that earns interest on a lump sum invested for a fixed amount of time. You typically need to leave your money invested for the agreed-upon period of time or you will be charged a penalty. You can sell them in the open market if you can’t wait for them to mature. CDs are also FDIC insured up to $250,000 per institution limit for a single individual, trust, or company, and $500,000 for a joint account.
If you had a larger amount of cash to hold, your advisor could also structure a CD ladder for you, which involves buying brokered CDs in your investment account that are issued at different institutions (to maintain FDIC protection) and mature at different times (hence the ‘ladder’ reference).
Funds invested in U.S. Treasuries are not FDIC or NCUA insured, but they are directly backed by the U.S. Treasury. The interest they pay out is also exempt from state and local taxes, which could be beneficial if you live in a high tax state. However, they are still taxable at the federal level. They are similar to CDs from the aspect that you should keep your money invested until the Treasury matures or you could lose some market value, but they can also be sold in the open market if absolutely necessary. Treasuries can be purchased through most financial institutions such as Schwab, Fidelity, and Vanguard, at banks or directly from the U.S. government on TreasuryDirect.gov.
Similar to CDs, if you have a large cash reserve to invest, you can talk to your advisor about structuring a Treasury ladder for you, with different amounts of money maturing at different times in the future. This ensures you have current income at set times while minimizing exposure to interest rate fluctuations.
Treasury Inflation Protected Securities (TIPS)
TIPS pay a fixed amount plus inflation and are backed by the U.S. government like Treasuries. Interest is also exempt from state taxes, and you can sell them in the open market if cash is needed. TIPS are typically sold on TreasuryDirect.gov and are issued for terms of 5, 10, or 30 years. You can also invest in a TIPS mutual fund or ETF in a brokerage account but be aware of the management fee charged for investing in such a fund before you buy.
As a high-level overview example, you could keep operating cash in your bank account, and invest your emergency fund (3-6 months of expenses) in a money market fund or high yield savings account. If you have additional cash reserves needed for something specific further out than 6 months, you can look into CDs or Treasuries.
Please one of our Austin Financial Advisors to help you figure out the best place to invest savings and cash since there are more options in the current environment as the Fed is raising rates. Even though rates are high at the moment, savings accounts are not a replacement for traditional long-term investments in the market. Research and data show that stock market investors have been rewarded by sticking with an allocation to equities over the long term. This is why we typically think about investing buckets of money depending on the time horizon and risk level.