One of the most common questions we get from our clients today is how much cash should I hold and what should I do with it? Here are a few things to consider when thinking about your cash levels and the different investment options for it.
To start, let’s take on the question of how much cash you should have on hand. While this number is different for everyone, there are a couple of useful things to consider when determining the right level of cash for you.
- First, do you have any large expenditures coming up in the next year? If 2022 showed us anything, it’s that market volatility can show up in a big way at any time. If you know you’re going to make a large purchase or have to pay a large bill within the next 12 months, it’s usually a good idea to set that money in cash so you know it will be there when you need it.
- Second, do you have funds set aside for an emergency? Unexpected emergencies happen occasionally, and they often have a financial component. It’s good to have funds set aside to handle the unforeseen curveballs that life throws all of us from time to time. For example, it’s unfortunate but anyone can get laid off. Having enough cash to cover 3-12 months of expenses can be a real-life saver if this unfortunate event ever happens to you.
- Third, what amount of cash would help you sleep better? This question is hard to quantify, and it’s different for everyone, but it’s important. Stock and bond markets are a really efficient way to grow your wealth long-term, but periods of jarring volatility are part of the deal. Having enough “sleep at night cash” can help you stay the course with your long-term funds, allowing the magic of compound interest to help you build wealth.
Now let’s highlight a few options available for your cash and give a few pros and cons of each.
- Certificates of Deposit (CDs): There have been a lot of news articles highlighting CDs lately. This is no surprise given their attractive rates. It’s pretty common to find one-year CDs paying 5% today, the most attractive rates in decades. And CDs also have the benefit of FDIC insurance. There are two drawbacks that you need to consider. First, CDs aren’t as liquid as the other options listed here. You can pick from a range of different time frames, but you’ll usually have to pay fees or sell at a discount if you need to access the money before the term ends. Second, CDs have a fixed rate, so if rates rise during your CD’s term, you’ll still be locked in at whatever rate you got when you originally purchased it. CDs can be a good option if you have a significant expenditure coming up on a known date. In this case, you can buy a CD that expires right around the date when you will need the funds, and because you’re earning interest, you can think of it as getting the bank to help you make the payment.
- High-Yield Savings Accounts: The benefit to these accounts is that they are highly liquid (usually, you can get your money in a day or so), and they are FDIC insured. The downside is they will typically have a slightly lower interest rate than the other options we will highlight here, with most high-yield savings accounts paying a little over 4% today. Their rates are also variable, so they work for you when rates are rising, but they can work against you when rates are falling. Despite these slight drawbacks, the combination of easy access and FDIC insurance can make high-yield savings accounts a solid option. In particular for any emergency funds you have set aside.
- Money Market Funds: Money market funds have some really attractive benefits. First, they are very liquid. Most of the time you can get your money in about two business days. Right now, most money market funds are paying around 5.0%, so the rates are very attractive as well. The downsides are that they are not FDIC insured, and the rates are variable, much like high-yield savings accounts. Moving out of a money market fund and into more growth-oriented investments like stocks or bonds is very easy if they are held in a brokerage or retirement account. This property can make money market funds a great parking spot for any money you may want to step into the market over time gradually.
Hopefully, this helps you think about how much cash to hold and what options may fit your situation. The good news is that with higher interest rates, these options are more attractive today than they have been in a long time. If you have questions or would like to discuss your situation further, give us a call.
Disclosure: All investments involve risk, losses may exceed the amount of principal invested, and past performance does not guarantee future results. This material is intended for informational purp