Stashing Cash

A common question lately has been about what to do with cash at the bank. Interest rates have been rising and have finally started lifting yields on certificates of deposit (CDs). But are rates good now or should you wait for them to go up? What about online banks, are they a good option? And how much money should you have in CDs anyway?

Before we can answer these questions it's best to define what we mean when we say "cash". As I see it, there are three primary types of cash and clearly differentiating them is important:

"Cash-Cash": My technical term for what should be in your checking account. This is cash-flow money needed for day-to-day spending, paying recurring bills, and so forth. In theory, this would have the lowest balance of your various accounts and only hold money that's realistically going to be spent within the next few months.

Portfolio Cash: This is cash in your retirement and brokerage accounts. It's not just lingering but is part of your overall stock/bond/cash allocation. This money is gettable in a pinch but should not be considered for month-to-month cashflow needs.

Emergency Fund Cash: While it's generally suggested to have 3-6 months' worth of spending stored in a special account, many people want to (and should) have more. For our purposes, let's define emergency fund cash as occupying that middle ground between money that's not needed immediately and money you're uncomfortable investing in your retirement account, for example. It could be saved for something specific or just be a buffer against the unexpected.

Let's focus on emergency fund cash and where to stash it, since that's the obvious place for something like CDs.

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Since the financial crisis, rates (interest earned, also referred to as "yield") on CDs and other short-term risk-free accounts had been kept low by the Federal Reserve to help stimulate the economy. The government wanted to force folks to spend by keeping yields on deposits well below the inflation rate, essentially making it painful to save. This eventually helped spur the economy and interest rates have been rising because of it. But its only been in the last several months or so that rising rates have trickled down to savers.

For years the national average 1yr CD rate was well below 1% but now it's closer to 2%. While they could climb higher in the near-term, yields are high enough to consider for some of your emergency fund cash.

Where can you get the best deal? Locally, Redwood Credit Union is offering 1.75% for 1 year and Summit State Bank has a 15mo CD for 2.25%. Both institutions have a $10,000 minimum and the yield declines if you drop below that mark.

A quick explainer: When looking at CDs you typically see "APY" after the listed rate. This stands for annual percentage yield and tells you how much you'll make should you hold the CD for exactly one year. APY is annualized, so if you're looking at the 15mo certificate referenced above, for example, you'll get 2.25% for 12 of the months and then another quarter of that for the remaining three months.

My first step in evaluating CD rates is to look at and do a search for 1yr CDs. This gives me a look at what online banks are offering. These banks often lack a national branch presence, so their costs are lower, allowing them to offer higher rates on CDs than the big-name institutions or local brick-and-mortar banks.

Currently, there are a few banks closing in on 2.5% for a 1yr CD. TIAA Bank leads the pack and is followed by banks that you might never have heard of such as Merrick, Barclays, Synchrony, and Pentagon Federal Credit Union. Who the heck are they? Are they safe? In a word, yes. Each of the banks listed by Bankrate is federally insured (FDIC for banks and NCUA for credit unions), so your deposits at each institution are covered up to $250,000 or more. Bankrate offers a "soundness" star-rating so it's easy to get a general idea of the health of the institution.

How much should you allocate to CDs? Here's a simple structure based on the relative size of your emergency fund. If you have:

3X monthly spending – no CDs, as your need for liquidity outweighs the potential for yield

6X – 50% of your emergency fund could go into a 1yr CD (nothing longer than that)

12X – 75% could go into CDs, maybe a little more, staggered at, say, 6mo, 9mo, and 12mo maturities

Notice a trend? Always try to have at least three months of cash available (at the bank, preferably, and not under the mattress). The bank will likely take some or all the interest you've earned if you need to withdraw cash early, so that's why you don't want 100% of your emergency fund going into CDs.

Remember, the primary reason you have an emergency fund is to have funds available when the unexpected strikes. The idea is to leverage your savings as much as possible while still being prudent and focusing on liquidity. It's thinking about the return "of" instead of the return "on" your principal.

There's a lot more that could go into this discussion. For example, I didn't mention buying CDs in a brokerage account or IRA, or why I don't favor buying longer-term CDs, so let me know of any questions.

Have questions? Ask me. I can help.

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