Interest rates are finally reverting to some sense of normalcy. For savers that’s great news. Now the question is, what’s the best harbor for your cash today?
As you’re probably aware, everyone’s talking about higher interest rates. After years and years of sub 1% returns all of a sudden we see 3.3, 3.5, 4. But with interest rate hikes not yet over, let’s talk about what the options are out there and keep in mind that all choices come with trade-offs. There’s no such thing as a free lunch when it comes to this treacherous field.
So when we’re trying to figure out what to do with cash, we have a lot of interesting options. In summary, there are banks, money market, mutual funds, ultra short term bonds and CDs. So let’s go over to the board and take a look at how these options pan out.
Let’s talk about the different cash options available. First, we’ve got the banks and the best banks are the ones with credit cards because they’ve got an immediate use for the money. They don’t need to give it to a third party, and worry about the collection. I like American Express. They’re paying 3, 3.5%. Now this is rotating. Capital One will be the top bank one month, another bank will be Chase. I really like Amex for a number of reasons. One, it’s a really easy setup. Two, they don’t send an army of salespeople after you to sell every other single product that their mega bank sells. So Amex is a great product at 3.5%.
Then we’ve got what we call money market mutual funds, and those things are a bit of an achronism from the old days. I’ll come back to that, but there used to be something called the Reserve Fund back in the day. Ever since that crashed and burned in 2008, we call it “broke the buck”. These things have been treated much more like regular short-term bond funds. So these have faded.
Then we’ve got the ultra short term bond funds and we’ve got CDs. CDs, of course are paying, you can get up to about 5% if you shop hard, but it’s not cash. These things are coming with 12 to 18 month lock-ins and they come with a slew of challenges.
Then we’ve got the USB, a great one for example, and it’s just an example is the Vanguard Ultra short term bond that’s paying about 4.7% no lock.
So what are the challenges? With the banks, Amex will not use an entity. Some of the other banks will allow entities, but you’re creating an administrative nightmare. Unless you’re planning on creating an entity every time a new bank has the best interest rate, I struggle with this option. Other banks have entities, but this is complexity.
Reserve funds. Reserve funds are in essence basically a variation on the theory of ultra short term bond funds. In 2008, when they broke the buck, they essentially vaporized. They still exist in name only. But if you’re going to do a mutual fund, why would you not do an ETF? ETFs, lower cost. So not an option in my book. Yeah, you can make them work. I wouldn’t bother.
The CDs. I loathe CDs with one exception, and that is if they’re a custodial buy sells. So what do I mean by that? If you go to the bank and you buy a CD at the bank, you buy a 12-month CD and it’s earned you a lovely 5%, for example. At the end of the year, it’s no longer the most competitive CD. What happens? First, unless you cross your Ts, dot your Is, they’re going to automatically renew the CD. Second, you have to get that bank CD into the correct entity. Third, transferring those dollars to a different bank because now you have a new deal, you have essentially just created a job for yourself. Not to mention your CPA is going to hate you and the bank’s going to love you. They use these as loss leaders to make it difficult for you to move.
Why would you go from 4.7 to 5.5 with a 12 to 18 month lock? People say, “But the principle’s guaranteed.” Well, it is if you hold it to maturity. However, if you need the money, then you’re going to have have to sell the CD and I can guarantee you, unless interest rates have dropped significantly, you’re probably going to sell it at a discount. You’ve probably locked in a loss along with the transaction and you may not even have that option with the bank. Only if you get it at a custodian does a CD make any sense whatsoever. Because at a custodian, you can cherry pick the banks all day long, and when that thing rolls over, rolls over to cash automatically, take the cash, you go buy another CD within your account. That can be Ameritrade, Schwab, Fidelity. So if you’re going to go with CDs, go with custodian buy sells, and make sure you’re matching your needs. If you know you don’t need it for one year under any circumstances whatsoever, okay, let’s go find you some CDs.
In a rising interest rate environment, even if it’s only rising slightly though, I wouldn’t want to lock those interest rates. I want to enjoy the ever-increasing interest rates. These things are fantastic. They have very, very, very slight principle fluctuation, normally plus or minus 0.1%. So there’s no guarantee of the dollar that you get with the old money funds, but in return for that you’re getting much higher yield that instantly ratchets up with interest rates. That’s a good thing. We don’t want to lock it. We can also sell these at a moment’s notice or even margin against them if we had some reason to do that. If we need the money for 48 hours, it might actually make more sense to margin for 48 hours and put the money back in the account than buy and sell the transaction. There’s no lock. There’s very little principle fluctuation.
What is the worst thing that can happen? What happens when you have interest rates being ramped up quickly? In the fall of last year to an extent never seen before and likely we’re not going to see again, we saw a slightly bigger principle reduction more than offset by the increase in yield since then. So that money has been returned to the clients in the form of much higher yield.
People get married to the concept of FDIC insurance, but what I tell people is if you’ve got an investment that’s made up of T-bills that are issued by the Federal Reserve and you’re worried about FDIC insurance, I promise you, when they’re not paying these, they are not going to be making payments on FDIC insurance. But in both cases, they’re going to make payments and it’s called printing money. What is printing money? We know what it is. It is inflation. So the guarantee with all these products is only, and to the extent they’re guaranteed by the government, is that if we have to we’ll inflate the money away. So you’re going to lose anyway. That’s the fundamental problem with cash. Cash will never keep up with inflation over time, especially not after taxes. So there it is. If you’ve got a need for money to be invested, if it’s less than $250,000 and you don’t need an entity, go find something like Amex. It’s online. We don’t get any money out of the deal. It’s a great opportunity. It’s easy to pair to your brokerage account if you want to move money back and forth. But for everything else, either use a custodian to buy and sell CDs or buy yourself ultra short-term bonds. You won’t regret it. We wish you the best of investing success.
Sources:
Paul is the founder and CEO of Avion Wealth, LLC. He leads a team of wealth managers in building and executing financial plans for high net worth individuals and families. Contact Avion Wealth to speak with a financial advisor.
