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How to Make Your Cash Work Harder as Interest Rates Rise

Christine Benz has some ideas on where your cash should go. And where not to go.

Susan Dziubinski 18 October, 2022 | 1:17AM
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Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Rising interest rates have taken a toll on the stock and bond markets this year, but there is a silver lining. Many savings vehicles now offer higher yields than they have in a long time. Joining me today to discuss the best places to park your cash as interest rates rise is Christine Benz. She's Morningstar's director of personal finance and retirement planning. Good to see you, Christine. Thanks for being here.

Christine Benz: Hi Susan, it's great to be here. 

  • It's important to not overdo cash savings mainly because, on an inflation-adjusted basis, this is dead money. 
  • An online savings account is a good option for those looking for yield but who need regular access to that money.
  • With planning, I Bonds can be a great option for investors.
  • For your cash reserves, avoid short-term bond funds and brokerage sweep accounts.

Dziubinski: So, now before we get into the specifics of "OK, where people should be thinking about putting their safe investmentswhere people should be thinking about putting their safe investments," how much should people really have in cash these days? You know, that's sort of a big question. And this year, considering what we've seen in the stock and bond markets, maybe some people wish they had a little bit more in cash than they originally did.

Benz: Absolutely. And it's such a good question, Susan. It's important to not overdo cash savings mainly because, on an inflation-adjusted basis, this is dead money. So, you want to be careful, but I do like the idea of people thinking about life stage and using that to influence how much cash they hold. So, the old rule of thumb for people who are still working is to have an emergency cushion equal to three to six months' worth of living expenses. That's a good starting point, but I like the idea of fine-tuning it. So, for example, if you're the sole earner in your family, that's an argument for having a little more, maybe a little closer to a year's worth of liquid reserves. If you're an older worker—we know ageism is a thing. We know older adults sometimes are not able to continue working as long as they might have hoped. If you're a high-income worker, you'd probably want to have a little bit more of a cash cushion set aside because we know that higher-income workers often have narrower focuses for their jobs. It often takes longer to replace those positions. So I would think of those groups as having a little closer to a year's worth of liquid reserves, assuming they're still working. 

For retirees, I've long been a fan of the Bucket approach where you've got one to two years' worth of portfolio withdrawals set aside in cash reserves. I like the idea of using your portfolio withdrawals as kind of a yard stick to drive how much to hold in each of the buckets. And so if you have that cash bucket, you would hold probably one to two years' worth of portfolio withdrawals, probably not a lot more than that.

Dziubinski: So, then let's talk a little bit about finding perhaps higher yields for your safe investments, and you think there are three key factors that investors really need to be thinking about when they're considering this. What are they? 

Benz: Right. So yield, certainly it's hard to ignore yield and that's what we're all looking for and talking about. But you want to keep that in mind alongside liquidity. So oftentimes when you see higher yields, so for example, CDs are a great example of that—certificates of deposit—where the longer the CD term is, the higher the yield. Well, that's a liquidity constraint, right? If you can't tap into your funds for five years, that's a trade-off on the liquidity front. And then guarantees are another thing to keep in mindthat many cash-type instruments are indeed covered by FDIC protections. Money market mutual funds, on the other hand, they're a commonly held cash accountvery safe in practical terms, but they are not covered by those FDIC guarantees. So, keep those three things on your dashboard: yield, liquidity, and guarantees.

Dziubinski: So, let's go through some of the specific ideas, starting maybe for the best options for people who are looking for yield but do need regular access to that money. What are some options for them?

Benz: My go-to for quite a while has been some sort of an online savings account. You can hop onto Bankrate and see what's on offer. You can see whether they have check-writing privileges, for example, and whether there's any minimum that you need to keep in the account. But right now it's not hard to find high-yield savings accounts that are paying out 3%, which is not bad for all that liquidity and FDIC guarantees. 

Money market mutual funds have also started to look a little better after a long fallow period where yields really were barely in the black. We've started to see better yields there as well. As I mentioned, they're not FDIC-insured, so you want to keep that in mind if having that rock-solid guarantee is important to you. But we are starting to see those higher yields coming online in money market mutual funds, and typically there's very good liquidity there as well. You oftentimes have a checkbook that you can use alongside that money market mutual fund.

Dziubinski: Christine, what about those investors who are trying to maintain safe reserves, but maybe they don't necessarily need ongoing access to the money. Liquidity isn't necessarily as important. What are some options there?

Benz: Certificates of deposit are a really nice option. We talked about how they aren't as liquid as a high-yield savings account, but certainly the yields look great. Looking at five-year CDs today you can find yields of 4% or so. Treasury bills are also having a little bit of a moment here in 2022. Treasury bills are issued by the U.S. Treasury. You can buy them at treasury.gov in increments of up to one year. You can find some nice yields there as well, and typically your income will be exempt from state and local tax. So another nice feature on Treasury bills.

Dziubinski: And then what about I Bonds? You know they've received a lot of investor attention this year and a lot of financial-media attention. What do you think of those as an option?

Benz: Well, they're a terrific option if you've planned ahead. I think an important thing to remember is that there are these purchase constraints surrounding how much you can buy in I Bonds. So, it's $10,000 per taxpayer, and then you can get an additional $5,000 in I Bonds through a tax refund. But it's also important to note that I Bonds don't have the same liquidity that you would have with a high-yield savings account or money market mutual fund—that you can't crack into your I Bond before a year is up, and in order to earn all of the interest on your I Bond and not forfeit any interest, you would need to hold for five years. So you can go ahead and start building a ladder of I Bonds. I think that's a really attractive strategy, but if you're just starting, just remember that the funds may not be as liquid as you might expect them to be.

Dziubinski: And then lastly, Christine, let's talk a little bit about what not to do with your cash reserves. Are there any account types that maybe if you're really looking for a safe investment, this is not where you should be looking?

Benz: Well, a couple of categories, Susan. I would say short-term bond funds would be one category. You will see somewhat nicer yields there, but you certainly do not have guarantees. Short-term bond funds have had some losses so far in 2022, so I would resist the urge to gun for a little bit more yield in any sort of bond fund. And then another category I always like to call out in this context is brokerage sweep accounts, which sit side by side with your investment accounts and typically receive in common dividend distributions, notoriously low-yielding account types. So if you have that sweep account and you're using it for convenience, just be sure to clear the money out of there periodically because the yields are really, really paltry.

Dziubinski: Christine, thank you for your perspective today. And I guess a little bit of good news in today's market, right?

Benz: We'll take it.

Dziubinski: We'll take it where we can get it. Thanks for your time.

Benz: Thank you, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.

This video was originally intended for a U.S. audience and was posted on Morningstar.com

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Susan Dziubinski

Susan Dziubinski  Director of Content for Morningstar.com

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