FINANCIAL LITERACY, INVESTMENTS
How Much Cash Should You Keep?
Joseph A. Davis, CDFA®
October 6, 2016
Keeping cash under a mattress may be an outdated idea, but it’s important to include cash or cash alternatives in your financial strategy. The amount of cash you need — and where to keep it — depends on your situation. To some extent, it’s a balancing act between short-term needs and long-term goals.
Interest rates on savings accounts — and cash alternatives such as certificates of deposit (CDs) and money market mutual funds — are very low, and it may take several rate hikes by the Fed before they begin to budge.1 Even with low inflation, these assets might lose purchasing power over the long term. However, the liquidity and stability of cash vehicles can be very helpful in the short term.
A typical guideline suggests having an emergency fund equal to three to six months of expenses, so you can pay bills in the event of a loss of income and meet unexpected expenses such as medical care, car repairs, or a new roof. For this purpose, a traditional savings account or a bank money market account (a savings account with limited check-writing privileges) can be helpful because the funds are readily available.
If you foresee needing cash in one year or more — for example, you expect to need a roof next year — you could put money into a CD, which typically pays a higher interest rate than a savings account. Keep in mind that CDs incur early-withdrawal penalties, so be sure you are comfortable tying up the funds until the CD’s maturity date.
Interest rates on cash alternatives dropped quickly after the federal reserve lowered the benchmark federal funds rate to near zero in December 2008.
Money Market Mutual Funds
Money market funds are mutual funds that invest in cash-alternative assets, usually short-term debt. They seek to preserve a stable value of $1 per share and can generally be liquidated fairly easily. Money market funds are typically used as the “sweep account” for clearing brokerage transactions, and investors often keep cash proceeds in these funds on a temporary basis while looking for another investment.
You might keep some assets in money market funds to balance riskier investments, but you should not look to them for growth. The amount you keep — other than funds for trading purposes — would depend on your asset allocation strategy. Asset allocation is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.
The Federal Deposit Insurance Corporation (FDIC) insures CDs, bank savings accounts, and bank money market accounts, which generally provide a fixed rate of return, up to $250,000 per depositor, per insured institution. Money market mutual funds are neither insured nor guaranteed by the FDIC or any other government agency. Although money market funds seek to preserve the value of your investment at $1 per share, it is possible to lose money in such a fund. The principal value of some cash alternatives may be subject to market fluctuations, liquidity issues, and credit risk, in which case there is a risk of losing money.
Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
1) USAToday.com, December 17, 2015
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2016 Emerald Connect, LLC.
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