Investing is an important aspect of growing your wealth, but it comes with a certain level of risk, this is why it's equally important for investors to find ways to maintain financial security. To maintain financial security, it is widely recommended that you keep a portion of your portfolio in cash. The exact amount of cash differs from person to person as everyone’s situation and lifestyle is different, but leading financial advisors generally agree on keeping around 10% of your portfolio in cash.
The main appeals of having a portion of your portfolio in cash are security and growth.
Security: Life is unpredictable. Having cash provides a financial and psychological safety net if something unexpected happens (e.g., getting laid off, unanticipated medical expenses, natural disaster). Furthermore, when markets are volatile, having cash can lessen the need to sell other assets in your portfolio.
Growth: Similarly, if you are presented with an investment opportunity, having cash on hand gives you the flexibility to act when the time is right and grow your money.
There are two main ways to hold cash: physically or through a bank via a checking, savings, money market (MMA), or certificate of deposit (CD) account. Having large amounts of physical cash is not recommended as it cannot earn interest, is hard to track and is not as secure as in a bank. Bank accounts are used for a variety of reasons, and each have their own features and drawbacks.
Checking Account: Checking accounts are deposit accounts used for everyday expenses and bills, providing access to your funds through ATMs, checks, and debit cards. These accounts typically don’t earn interest and have no withdrawal limits.
Savings Account: As the name implies, savings accounts are used to allocate funds that are not for everyday use. Rather, they are used for things like an emergency fund or saving up for a down payment and other long-term goals. Savings accounts are interest-bearing, meaning that the bank will pay you a certain percentage of your holdings for keeping your money at their bank (usually daily or monthly). These interest rates are usually variable, meaning that they change in accordance to a set of factors determined by each individual financial institution, and offer a low yield, with the national average yield for US savings accounts being 0.25 average percentage yield (APY) according to Bankrate. You are not provided with debit cards or check-writing abilities.
Money Market Account: Money market accounts offer some of the benefits and features of both checking and savings accounts. MMAs are interest-bearing and typically offer higher rates than a traditional savings account. This is possible because banks that offer MMAs invest deposited funds into relatively higher risk investments such as short-term government deposits and commercial paper. Banks also require a minimum deposit amount to open an MMA and impose fees if your balance dips below a certain level. Like checking accounts, MMAs include debit card and check-writing privileges. These privileges come with restrictions, such as transaction (withdrawals, transfers and checks) limits ranging from three to six transactions a month. Exceeding the amount can result in additional fees.
Certificate of Deposit: A certificate of deposit (CD) is another form of savings account that earns interest over a fixed period. CDs differ from other interest-bearing accounts because the deposited amount cannot be accessed for an agreed-upon term or else you could face penalty fees. Term lengths can range from one month to 10 years. Unlike MMAs and savings accounts, interest rates for CDs are fixed (unchanging), which many investors prefer because of its long-term stability. Because of the time commitment and the lack of immediate liquidity, banks are generally able to offer higher interest rates on CDs than MMAs or savings accounts.
Aside from the various ways you can earn interest on your money, one of the most attractive features of holding cash in a bank is the fact that deposits up to $250,000 per depositor, per insured bank, for each ownership category are insured by the Federal Deposit Insurance Corporation(FDIC). Due to the failure of SVB and First Republic Bank, the FDIC has been receiving a lot of attention over their insurance policy. To avoid confusion, we’ve compiled some of the most common questions and misconceptions about FDIC insurance for you:
This means that the FDIC insures all the deposits that one person (depositor) has in one insured bank up to $250,000. This includes all branches of that insured bank. Ownership category refers to the owner of the account. There’s a host of account ownership categories such as single (one owner) and joint (two or more owners) as well as certain retirement accounts like IRAs and trust accounts. Different categories are insured individually, meaning that you could qualify for more than $250,000 in coverages if your cash is held in different ownership categories.
No. FDIC coverage is limited to the accounts listed above, so in the event your bank fails, only the money you have in those accounts is protected. Safe deposit boxes, even though they are located physically inside a bank, are also not FDIC insured.
A common myth about the FDIC is that they can take up to 99 years to pay depositors back. According to the FDIC’s website: “the truth is that federal law requires the FDIC to pay deposit insurance ‘as soon as possible.’ For insured deposits —those within the deposit insurance limits — the FDIC almost always pays insured depositors within a few business days of a closing, usually the next business day.”
There are a multitude of ways to allocate and earn interest on your cash, all of which have their own benefits and restrictions. When choosing where to put cash, it’s important to know the nuances of both the account that you’re putting it in as well as the organization insuring it. In our next blog, we will discuss how to make sure that your money is FDIC insured, even when you have over $250,000 cash.
.svg)
