The 4 Ws of Cash Management
What is a cash reserve?
A reserve of cash is important to pay for ongoing expenses—such as credit card, medical, and tuition bills—and to cover large annual costs, such as property taxes. A cash reserve also provides a buffer for unexpected emergencies so that a surprise expense does not require a withdrawal from your investment portfolio.
Why hold cash?
We recommend our clients keep three to six months of living expenses in cash at all times. Aim on the high end of the three-to-six month spectrum (or overshoot it) if your job security is questionable. A lower reserve is fine if your income comes from guaranteed sources, such as pensions. Hold all cash reserves in an account that’s fully liquid—meaning you can make withdrawals at any time—and preserves your principal. FDIC insurance covers a variety of accounts at eligible banking institutions. The standard insurance amount is $250,000 per depositor, per insured bank, per account category. See the FDIC website for more information about federal deposit insurance.
Where should cash reserves be held?
Years ago, mutual fund companies, such as Vanguard and Schwab, offered high-yield money market funds in the 5% yield range. Today, online banks whose accounts are FDIC insured may be your best option to earn a whopping .90%. To find an FDIC-insured high-yield cash account, start your search by looking for national high-yield money market funds on BankRate.com. Online banks generally offer higher rates than banks with physical branches, although you may find special rates offered by your local bank. Expect the best rate to be in the .90% range. Be sure to note the minimum deposit to open an account and any monthly fees (though some banks waive monthly fees if you hold a minimum balance).
When should you reserve even more cash?
Remodeling or buying a home? Expecting to buy a new car? In addition to ongoing cash reserves, there are times when you need cash for an upcoming planned expense. If you can project the timing and dollar amount of your cash needs, you may invest in two- or three-year CDs that mature when you need the funds. This is known as “maturity matching,” and a savvy financial planner can strategize the specifics with you. Keep in mind that if you need the cash before the CDs mature, the penalties you’ll have to pay may wipe out the benefits of a higher rate. Understand any potential penalties before locking up your cash. And be sure not to roll over a CD at maturity to the then-standard rate (which may be lower than your original rate). Search for the best CD rates in the nation by maturity term on Bankrate.com, or check with your local bank.
Discovery is your best defense.
Today, there are no good options for cash reserves to keep pace with inflation. And it may be tempting to take on too much risk with your cash. Be sure you have answers to these questions before investing or locking up your cash reserves:
- Will my principal be preserved?
- What does the holding invest in? (If the answer includes stock or any bonds with a maturity longer than three months, you should be concerned.)
Just as you wouldn’t want to take too much risk with your investment portfolio, you don’t want to take too much risk with your cash. Have those emergency reserves available if and when you need them.