Only 18 months ago, managing cash was not something that anyone was really thinking about. However, the Federal Reserve’s Federal Open Market Committee (FOMC) has raised interest rates 11 times since March 2022 to combat the worst inflation the U.S. has seen in 40 years, taking short-term rates from 0% to over 5%.
While inflation has gobbled up any return earned on cash over the last year or so, there are now more creative ways to ensure that your short-term reserves are better positioned to earn the most you can and maximize your interest in the future. Often it means doing more than just leaving cash in your regular savings account.
Open an online savings account:
Online banks do not have a physical presence, which typically leads them to paying more interest than traditional banks with branches. A quick internet search shows the well-known, traditional banks paying Annual Percentage Yields (APY) of less than 0.50% on savings accounts versus online banks paying between 4.15% to 4.30% APY as of early August this year. Online banks are best used for your emergency and opportunity fund, or a reserve for future estimated taxes, and not typically for your everyday banking because it usually takes at least one business day to transfer money to and from the account. Some of the online banks do have minimums, so please make sure you do research to see what bank might be best for you.
Buy a CD:
Certificates of Deposit, or CDs, are another way that you can earn more interest on your cash. They are offered in maturities ranging from 3-months to longer than 1-year and typically have higher APYs than online savings accounts. However, they come with some drawbacks such as waiting until maturity until you receive your interest, and penalties in the event that you need to access the money in the CD prior to maturity. One common misconception with CDs is that the rates are quoted in annual terms, meaning that a 9-month CD paying 5% does not earn you a full 5% over the nine months. It earns roughly 3.75%.
Purchase short-term Treasury Bills
The U.S. government does not raise enough revenue through taxes to pay for everything that is spent. Therefore, it borrows money from investors by issuing Treasury Bills, Notes and Bonds. These instruments maturing in one year or less are called Treasury Bills and have many options for maturities. The most common of which are 1-month, 3-month, 6-month and 1-year. While not always the case, these Bills yield more than online savings accounts and CDs issued by banks and come with the backing of the full faith and credit of the U.S. government. They can be purchased through many brokerages as well as through the Government’s website, TreasuryDirect.gov.
Invest in a money market mutual fund:
Money market mutual funds are pooled investment vehicles that invest in low-risk, short-term and liquid securities, some of which have been mentioned above. They aim to maintain a stable value of $1 per share and are a relatively safe option to earn higher interest on cash than is typically offered in savings accounts. However, these funds are securities and regulated by the Securities and Exchange Commission (SEC), meaning that they do not come with the same level of guarantees as some of the other options mentioned above.
Creating your strategy
There are many opportunities to manage cash and there isn’t a universal solution that fits every scenario. Your best strategy is likely a blend of the options listed above, tailored to your own personal circumstances. Every solution above represents its own trade-off in terms of risks and so it’s important to do your homework before deciding your ultimate strategy. By delving into the details and understanding the implications, you can design a strategy that aligns with your goals and helps you maximize your interest with confidence.
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