During the last eighteen months following the financial crisis we have had a lot of discussions about cash – how much to keep on hand and where to keep it. In the past, it was common to have only a small amount of cash on hand, and to save and invest anything above that.
There were a lot of reasons not to keep large amounts of cash around. For example, saving into retirement plans moves money into a tax‐advantaged arena, protects it from the reach of creditors, removes it from being counted towards financial aid, and has other similar benefits. Also, in the past most people had a home equity line of credit to draw from in an emergency. Home equity could be borrowed cheaply and with some tax advantages.
However, most of our attitudes towards debt and cash have changed. In today’s environment, even the most stable of jobs can be laid off. Our self‐employed clients are working harder to find new customers to maintain revenue. Home values have dropped, causing banks to reduce or eliminate many homeequity lines. The bottom line is that everyone should have a solid rainy day fund available in case life throws you a curve.
How much should I have?
It’s a balancing act to determine how much to hold back, and how much to invest. Some clients just like to have a lot of cash nearby. It makes them feel better and sleep more soundly at night. Others want to invest everything for fear they won’t get enough return in cash, or from a fear that holding cash will tempt them to spend it.
Probably the best way to approach this issue is to dedicate funds towards their purpose. For example, if the purpose of your cash is to provide for your emergency needs if you lose your job, try to estimate the time it would take you to find a new position in a similar role. For some jobs and industries, that process could take only a few weeks. For others, a job search may take a full year. Of course, your investment portfolio can take care of some expenses, as long as there is enough time to weather severe market drops.
|A Word on FDIC Insurance: Generally, accounts at banks insured by the Federal Deposit Insurance Corporation (FDIC) are insured up to $250,000 per depositor per bank (thru 2013). This insurance covers checking, savings, CDs, and money market accounts. FDIC insurance is per ownership type, so you cannot increase your protection simply by opening more than one account in your name at the same bank. However, deposits that represent different categories of ownership may be independently insured. For example, a joint account qualifies for up to $250,000 of coverage for each person named as a joint owner of the account. That coverage is in addition to the $250,000 maximum coverage for individual accounts for each person. So a married couple with three accounts at one bank–they each have $250,000 in an individual account, and they also have $250,000 in a joint account–would qualify for FDIC coverage of the entire $1,000,000.|
The general rule of thumb on how much cash to have on hand is three to six months of your living expenses. The easiest way to figure out your living expenses is to simply add up your monthly income (i.e. your paycheck after taxes, 401k savings, and other deductions), subtract any additional savings, and subtract any regular income NOT coming from work (such as social security, disability income, or a pension). Take the result and multiply it by three to six – use three if you have a very stable position, such as a government job. Use a higher number if your income is more variable or unstable.
There are other variables that would change the amount of cash you need on hand, such as if you have short-term disability insurance, if you are a single vs. dual income household, and if you have passive income sources. Each situation is different, so feel free to call us to discuss your particular situation.
Where should I keep it?
Now, the question is where should you keep your cash? Remember that safety and flexibility are the primary goals – not return. So don’t concentrate on the rate, because you will inevitably sacrifice either safety, or flexibility, for a higher rate. Generally, a money market or CD account at a FDIC insured bank or NCUA insured credit union are the best options. Many clients ask us about keeping cash at Schwab. While we obviously like Schwab for investment accounts, it may be a good idea to keep cash separate for clarity’s sake.
According to Bankrate.com, the average yield on a 6‐month CD is about 1%, and a 1‐year CD will get you about 1.4%. You can get higher rates, but remember that for the bank to offer a higher rate probably means that the bank needs to raise capital, which can be a sign of a weak financial condition. As long as the bank is FDIC insured, you will get your money back (up to the FDIC limits). However, it can be somewhat of a hassle to go thru a bank failure, because the FDIC will have to transfer your accounts to another bank. At that point, your rate will probably be lowered anyway.
The Missing Link
Schwab offers a free electronic service to link any bank account to your brokerage accounts. Most of you already know about this, and probably already have one setup. But, if not, feel free to contact us on how to do this. It’s called Moneylink, and it allows you to transfer funds online between your Schwab accounts and your bank accounts at any time. The transfers usually take between 24 to 48 hours to process, with most of them finishing closer to one business day. This can be a valuable feature for anyone needing to move money securely without a lot of hassle.
As always, if you have any questions, we are here for you. I hope everyone has a wonderful March!
Curtis Hearn, MBA, CFP®