Bank it: Make the most of cash with rising rates

It was less than a year ago when interest rates (1.5%) were at historical lows, and financial pundits were calling cash trash.  (Remember those days?)  Earning a pitiful 0.80% or so in an online savings or money market account, cash yielded a negative return when factoring in (then) equally low inflation (2%).  

How things have changed within the span of a few months!?!?  Due to a confluence of events (e.g., pandemic, stimulus checks, supply chain issues, Fed low-rate policy, tight labor market), high inflation level (6-7%) not seen since the 80s has come roaring back and, thereby, destabilizing individuals and companies alike.  Beginning in 2022, to combat this new threat, the Fed has taken a more aggressive approach by increasing interest rate in increments of 0.75% vs 0.50% or 0.25%.  Given the dramatic unfolding of financial events, I thought it important to revisit age-old assumptions and questions relating to cash to ground my own understanding and, thereby, (in)action in the unfolding monetary maelstrom:  Was cash ever trash?  What is the purpose of cash?  How to make the most of cash in this (or any) environment?  

The importance of an emergency fund (cash) 

Just to level set, when talking about cash, I’m mainly referring to the often overlooked emergency fund that we’re all told (or scold) to establish just in case life happens, and it always does sooner or later.  With that said, in my opinion, those who refer to cash as trash may not be evaluating it holistically and/or mixing metaphors.  Cash’s power lies its universal acceptability, portability, liquidity and optionality.  In wardrobe terms, cash is the crisp white shirt; black pair of slacks; well-fitting, broken-in pair of jeans.  Cash is the foundation upon which financial well-being is built, and the unassuming emergency fund is the cornerstone of that foundation.  Whether your goals are short-, mid- or long-term, the emergency fund helps make it all possible by:

·      Allowing you to pay for unforeseen expenses without tapping into high-interest debts (e.g., credit cards).

·      Providing you the psychological cushion to ride out market volatilities and downturns…So, in other words, buy and hold. 
    

How much cash to hold in an emergency fund?  

Given the importance of cash, how much is enough?  The amount varies depending on your circumstance, psychological disposition and where you get your financial news/info.  The oft-quoted recommendation is to set aside 3-6 months’ worth of living expenses in cash.  However, since I’m fiscally conservative and for the sake of simplicity, I typically recommend that clients hold 12 months’ worth of living expenses in cash.  Yes, yes, I realize that one can earn a higher return by putting some of that cash to work in the stock market, instead.  Still, how does one compare peace of mind versus greater return?  Just to make things more complicated, are the two mutually exclusive, inclusive or both?  Regardless, I view this as an intellectual exercise, which is fun, but not very practical or financially material in the grand scheme of things.  So, feel free to choose a cash cushion (6-12 months’ worth of living expenses) that best suits you.     

Banking strategy 

When it comes to your emergency fund, the goal should be capital preservation versus capital appreciation.  Still, that doesn’t mean that your cash has to sit idly earning nothing.  One simple banking strategy that balances accessibility with earning interest is to couple a brick-and-mortar bank with a high-yield online savings account.  In the brick-and-mortar bank, consider putting in a month’s worth of living expenses to pay ongoing, short-term bills and whatnot.  Meanwhile, in the online savings bank (account), put the bulk of your emergency fund so that it can earn as much as possible as it waits.  

When choosing an online bank/savings account, rather than base your decision on interest rate alone, it’s important to factor in other criteria first: institutional reputation; financial strength; FDIC insured; few requirements/stipulations; simple user interface (UI).  Given these criteria, my favorite online bank and savings account are Ally Bank and Capitol One 360.  Additionally, Ally and Capital One savings account pay 1.25% and 1.20% in interest, respectively.  This is 10-20xs higher than what most brick-and-mortar savings account pay.   

Other ways to earn higher interest (sort of) 

For those looking to eke out an even higher yield on cash, another possible strategy is to build a CD ladder in 3- to 6-month increments.  However, my guess is that the Fed will raise interest rates quicker and sooner than expected to fight inflation.  So, the best strategy may be to let your cash ride with the tides by leaving it in a high-yield online savings account versus locking it up (albeit temporarily) in potentially lower yield CDs.

Also, not long ago there was a good deal of talk about the value of I bonds, foremost being its ability to outrun high inflation.  Thing is, there are a number of stipulations/requirements regarding I bonds, such as where you can purchase it; how much you can purchase per year; how long you have to hold it to collect full interest; how to cash out.  For example, Treasury Direct (https://www.treasurydirect.gov/), the government website where you can buy I bonds, is rather antiquated.  (It was last updated 20 years ago.)  As is, the site feels like a roach motel.  You can put money in, but it’s difficult to take it out as the user interface is counter-intuitive (to put it mildly).  Also, an individual can only buy $10,000 worth of I bonds per year.  Given all the hurdles, in my opinion, I bonds are more hassle than they are worth.  Still, if you have patience and time, by all means…           

Final thoughts…

Short of Armageddon, cash will always have some value given its universal acceptability, portability, liquidity and optionality.  The unassuming emergency fund allows you to address short-term expenses so that you can achieve long-term goals via investing in the stock market.  Capital preservation begets capital appreciation.  So, the next time you hear someone trash cash, ask yourself what would happen if oxygen runs low.