Get adequately paid for your cash
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Let’s start by getting to the point. You should call your bank and find out what you are making on your cash.
Do not assume you are receiving an adequate rate of interest. In fact, you should likely call your bank even if you asked this exact question 4 months ago. Recent interactions with clients have led us to the conclusion many savers are likely underpaid in their savings accounts. In many cases, banking clients are finding their interest rate is more than 3% below current market rates.
Inflation and rising interest rates
Inflation and rising interest rates have been the predominant topic in the financial media for most of the last few years. If you follow financial markets, you will recall that early in the COVID-19 pandemic, rising prices impacted lumber, housing and then new and used cars. Supply chain disruptions were blamed for the price increases in 2020 and early 2021. Eventually, inflation touched every part of our lives, as gas, food, rent and services experienced double-digit price increases. We all have some level of inflation fatigue.
Most investors understandably associate inflation with rising interest rates. The Fed (Federal Open Market Committee) typically raises interest rates to fight inflation, leveraging the policy as one of many tools at its disposal.
You may be asking: Why are inflation and rising rates relative to the yield you are receiving on your cash? One year ago, the Federal Funds rate was still at 0%. The first-rate hike of the present cycle occurred on March 17, 2022. Savers become accustomed to earning 0.01% on their cash. Conditions quickly changed. Inflation skyrocketed and the Fed began to aggressively increase rates throughout 2022. By January 2023, the Federal Funds rate was 4.25%. Fed action is notable because the Federal Funds Rate influences the rate paid on certificates of deposit (CDs), treasury bills and commercial paper. Money market funds are buying these products; therefore, yields of money funds are also influenced by the Federal Funds rate.
Investors now have a variety of low-risk vehicles at their disposal that allow them to earn yields exceeding 4%. However, most banks have yet to proportionately increase the rates paid on savings and checking accounts.
Banks are very aware most of their customers do not closely follow financial markets. They are also not in the business of cutting their own profit margins. Consider the pace of rate increases, and you understand why savers are underpaid at historic levels. A 30-year mortgage will cost you more than 6%; however, bank clients may only receive 0.5% on a savings account. Investors can easily find CDs, treasuries or money market funds that will pay more than 4%. Leaving an excessive amount of cash in a savings account paying less than 1% interest is the equivalent of paying a financial institution 3% to hold your money. You would not pay a financial advisor 3% for asset management and financial planning, and there is certainly no reason to pay 3% for FDIC insurance.
Next steps
The distinction between checking accounts and savings accounts should be clarified. A checking account offers functionality that you cannot receive from money markets or CDs. You may have to accept below-market yields on the account you are using to cover daily or monthly expenses.
The first step is to evaluate low-yield bank accounts used for emergency savings and any funds you elect not to invest for peace of mind. Cash allocated for annual tax liabilities, future home purchases or other unique lump sum purchases may be appropriate for some of the previously mentioned higher-yielding vehicles.
How much money should I keep in cash equivalents? Typically, 6 months of living expenses are advisable for emergency funds. You may want to increase that amount if you have highly variable compensation, health risks or other factors that could impact cash flow.
Which investments are suitable to replace my savings account? The best advice is to encourage a conversation with your financial advisor to determine which product should replace your low-yielding savings account. A description of the products most frequently used by investors is listed below.
Money market funds are popular, due to the accessibility of cash. Investors can typically access funds in 1 to 2 days. Money markets are invested conservatively as they are required to purchase securities. A money market fund owns short-term debt. Most will have substantial exposure to U.S. treasuries. The name of the fund will often provide insight into the types of securities the fund is purchasing. However, we would caution against making purchase decisions based solely on the fund name. Principal in a money market fund is not guaranteed; however, the funds are typically backed by the financial institution offering the fund. The quality of the underlying investments within the fund can be an important factor during times of high economic stress.
Treasury bills and bonds are backed by the U.S. government. Investors will not lose principal in treasuries, provided the investment is held until maturity. Treasuries are very liquid and can easily be sold if an investor needed to access the funds prior to maturity. What is the risk associated with investing in treasuries? The risk is minimal. If an investor was forced to sell a treasury prior to maturity in a rising interest rate environment, there is a possibility of a small loss of principal.
CDs provide FDIC insurance up to $250,000 per depositor, per insured bank, for each ownership category. FDIC insurance provides coverage against bank failures. CDs are similar to treasuries in that they offer defined maturity dates. Typically banks issuing CDs will permit an early redemption, but penalties will be assessed for premature liquidation.
Conclusion
The underpayment of interest is yet another example of the conflicts within the financial industry. Investors should be skeptical when accepting advice from an individual employed by the institution holding their assets. Working with a fiduciary who is independent (not employed by your custodian) will allow you to avoid an arrangement where your advisor is compensated based on the products you are purchasing.
A call to your bank could save you thousands of dollars. Please feel free to reach out to OJM Group to determine which solution is an appropriate alternative to a low-yielding savings account.
Reference:
Wealth Planning for the Modern Physician and Wealth Management Made Simple are available free in print or by ebook download by texting HEALIO to 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.
David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group, www.ojmgroup.com, where Andrew Taylor is a partner and wealth advisor. You should seek professional tax and legal advice before implementing any strategy discussed herein. They can be reached at mandell@ojmgroup.com or 877-656-4362.
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