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October 27, 2010
Greetings!
An important component of a financial plan is to have cash reserves set aside in savings and money market accounts to use for emergencies and other short-term expenses. The amount of cash reserves will depend on your particular situation and needs. Unfortunately, many savings and money market accounts are currently earning almost zero interest. This is frustrating, because everyone wants their money to be earning something. So it is understandable that you may contemplate investing those funds in the hopes of receiving a better return. During low-interest times like we're experiencing today it is important to remember that the reason for keeping a cash cushion is so there would be no risk of loss and the funds would be available quickly when needed. Other types of investments, though tempting for their higher return potential, could lose principal. Which would concern you more; earning zero in interest or taking the chance that your reserves could decline in value by the time you need the money?
Let's look at an example to illustrate this point. Suppose you had $20,000 in a savings account earning the following interest amounts for one full year. If you earned:
- 0% annually, you would earn nothing on your savings for the year
- 1/2% annually, you would earn $100 over the course of the year ($8.33 a month)
- 1% annually, you would earn $200 over the course of the year ($16.67 a month)
In each of these cases, you still have the original $20,000 that you set aside in savings - no principal was lost, just varying amounts of interest income were earned.
So what options exist for earning the maximum on your "safe" money? Here are a few ideas to earn a little extra:
- Place some of your excess reserves in CDs. Since interest rates are really low at the moment, keep the maturity under 12 months so you have the potential to roll into a higher rate later on if interest rates start to go up.
- Some credit unions are offering checking accounts that pay a higher interest rate, but you must meet certain requirements to qualify. If you are considering one of these accounts, discuss the requirements in detail with the credit union.
- If you are comfortable banking via the Internet, consider using one of the online banks for part of your reserves. Online banks often pay a higher rate than "brick & mortar" banks and are usually FDIC insured.
Sincerely,
Your team at Johnson Bixby & Associates
Investment returns in this example are hypothetical and do not represent the return of any particular investment; nor do they guarantee that your investment results will be similar. Hypothetical returns do not take income taxes into consideration. Your investments may grow or decline at higher or lower rates, depending on market conditions.
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