Allison Dubreuil, Wealthway Financial Advisors: Tonight we’re going to talk about something we haven’t talked about in probably a decade. Eight years or so we haven’t. There’s been no point in even paying attention to this for so long. But we’re starting to get questions about cash. Where do you park your cash these days?
Kevin Zywna, Wealthway Financial Advisors: When we say cash, we mean very liquid bank savings type of accounts. So not actual physical bills.
Allison Dubreuil, Wealthway Financial Advisors: Those go in the freezer.
Kevin Zywna, Wealthway Financial Advisors: Yes, we’re not actually talking about the currency cash. But the short term savings money for your emergency fund, or for upcoming vacations or for potential house remodel. Over the last almost 10 years, the rates of return on cash have been negligible. As close to zero as you can pretty much get. 0.01% in many cases on basic savings accounts. Now, a lot of that has been driven by the historically low interest rate environment we were in for about the last 10 years. Now with an increase in inflation and a corresponding increase in interest rates has come an increase in savings account rates. We thought we’d delve a little bit deeper into how you can maybe earn a little bit more on that short term money but still keep it safe and liquid.
Allison Dubreuil, Wealthway Financial Advisors: Yes, first, let’s just address how much you should keep in the bank. It’s very personal. It depends on your personal financial situation. But a very general rule of thumb is that you should have between three to six months of living expenses set aside in a rainy day fund. Now if you have unpredictable income, you might want to have a little bit more. Or if you have short term goals, we define as three years or less, if you plan on buying a home or doing a big renovation or taking the trip of a lifetime, then that might be a reason to keep more than just your basic three to six months’ worth of living expenses. But once you’ve got that true emergency fund, you really want to invest anything else that’s not needed in the next one to three years.
Kevin Zywna, Wealthway Financial Advisors: And before we get into some of those details, as promised, when we have a caller on the line, we are going to go and speak to that caller right now. We’re going to Carrollton and speak to Warren. Good evening, Warren, you’re on Dollars & Common Sense.
Caller: My question is on required minimum distribution, which I will be doing this year. I have two qualified accounts. One is an IRA and the other one is a 401K. My question is, does the calculation for that require you to remove amounts from each account? Or do they let you aggregate it, and you pay basically, one payment for the RMD?
Kevin Zywna, Wealthway Financial Advisors: Okay, good question, Warren. Are you still employed?
Kevin Zywna, Wealthway Financial Advisors: Okay. Would you consider yourself fully retired?
Allison Dubreuil, Wealthway Financial Advisors: Okay, so it’s a good question, Warren. With individual retirement accounts, traditional IRAs, SIMPLE IRAs, SEP IRAs, you are able to aggregate the required minimum distributions and take them from one account, if you would like for various reasons, investment reasons, or allocation or what have you. My understanding is that 401K required minimum distributions do have to come out of their specific plan.
Kevin Zywna, Wealthway Financial Advisors: Yes, usually, because there’s a separate plan administrator who is responsible for ensuring the correct amount of the required minimum distribution. So that one kind of does get carved out a little bit. But technically, you, the taxpayer, are responsible for making sure you take out the total required minimum distribution, whether it’s two plans, one plan, or you could have five or six different IRAs spread out, we wouldn’t recommend that but some people do. You don’t have to take it out of each of them pro rata. You do have to take out a total amount to satisfy the RMD. Does that make sense?
Caller: Do you know if the IRS forms guide you through that or do you have to guess.
Allison Dubreuil, Wealthway Financial Advisors: The calculation, you mean?
Caller: Well, actually, if I have to take a certain amount of out of the 401K, and then out of the IRA, does the form guide you through doing that?
Kevin Zywna, Wealthway Financial Advisors: Yes. Well, just to clarify, if it is like Allison was saying, typically, the money you have to take out a 401K will probably be handled by your employer’s third party administrator.
Allison Dubreuil, Wealthway Financial Advisors: Yes, so I don’t know that you necessarily need a form. I guess that would depend on your custodian, whoever’s holding your accounts. And each custodian usually does the calculation for you on what is required to come out of each of your accounts. And then you can give them instructions on where you want to take it from. The IRAs can be aggregated and the 401Ks are each their own distinct bucket.
Caller: Okay. All right. I understand.
Kevin Zywna, Wealthway Financial Advisors: A lot of times nowadays, Warren, they’re putting that required minimum distribution dollar amount on your monthly statement. You might want to check that (if they’re good custodians).
Caller: Well, I appreciate the help.
Kevin Zywna, Wealthway Financial Advisors: Okay, Warren, thanks for the call.
Allison Dubreuil, Wealthway Financial Advisors: It’s one of the many good reasons you may want to consider consolidating when you retire. Because if you have all these different buckets, it does become a lot to keep track of. We always like the idea of simplifying and consolidating. You can roll, old 401K plans into your individual retirement accounts and just have one distribution to worry about each year.
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Kevin Zywna, Wealthway Financial Advisors: Tonight, we’re talking about cash what to do with your
short term savings money, your emergency fund. We are in a rising interest rate environment, that means now you could probably make a little bit of money on your cash holdings, if you arrange it properly.
Allison Dubreuil, Wealthway Financial Advisors: Yes. You want to give some thought to where you’re going to park your cash because now it is starting to matter a little bit more. You want to take your time and think through some main factors when you’re looking at what type of cash account would suit your extra money best. You want to think about access. How often will you need to access these funds? Do you need check writing? Does anybody write checks anymore?
Kevin Zywna, Wealthway Financial Advisors: Right, the checking account is going to become a misnomer. Like my kids are like what is a check?
Allison Dubreuil, Wealthway Financial Advisors: You do want to think about access. Whether you need quick access to this money or if it really is truly out of sight out of mind, you do want to start paying attention to interest. So different account types will give you more money for keeping your cash there. But there are trade-offs. The higher the interest, usually, there are maybe higher fees or less access or some sort of trade-off. And then you want to consider service. Some people are fine with a completely online bank, and that suits them just fine. And there are others that still want that brick and mortar building with a branch where they can go in and talk to someone and get help. So that might guide your decision making on where to park your cash. And finally, penalties. You want to be aware of, if there are any sort of penalties associated with getting access to your cash before a certain timeframe so that you don’t end up being penalized for accessing it.
Kevin Zywna, Wealthway Financial Advisors: And to put a little bit finer point on some of the numbers. We’re starting to see now, interest rates above 4% on certain types of savings account vehicles. Four to four and a half percent would be reasonable in this environment. We are certainly seeing some bank CD’s around that level as well, some even 5% if it’s a longer term CD. That’s a decent number. To put it all in context, though, bank interest rates and inflation tend to march arm in arm.
The reason we’re seeing higher interest rates on bank savings products is because we are also experiencing, unfortunately, higher rates of inflation. And while it’s important to have some money in bank assets, typically in most environments, you’re always going to earn a little bit less on your bank savings rates than your experience in the prevailing rates of inflation. There can be anomalies from time to time, but that’s why we want you to keep some money in the bank but not too much extra. The excess money should be redirected into company retirement plans or invested for long term growth if you’re looking to maximize your net worth.
Allison Dubreuil, Wealthway Financial Advisors: Right. We do come across that a lot. People take a lot of comfort in those guarantees of the bank money, not realizing there is still risk in bank money. It’s inflation risk and it is eating away at your purchasing power. It’s a balance between keeping what you need for short term and emergencies and trying to maximize your interest rate or rate of return.
Kevin Zywna, Wealthway Financial Advisors: So probably the first and obvious place to park money in a bank savings account is a checking account. A checking account is really designed for spending that is your transactional account for paying all your regular bills. Because it is a high transaction account, you typically earn the lowest amount of interest on your checking account, if you earn any interest at all on a checking account. It’s typically lower than whatever prevailing rates are. But that’s not the main purpose of the checking account, the checking account is to make sure the bills are paid in a timely fashion so it’s understandable that the rates would be lower there. Don’t over fund your checking account. I like to keep the bare bones, like by the end of the month getting close to zero before it’s reestablished. The point of the checking account is transaction, pay the bills, you’re going to earn the lowest rate of return out of that account. Don’t load it up with excess cash.
Allison Dubreuil, Wealthway Financial Advisors: Yes, about a month. The next step up from checking accounts are regular savings accounts. Savings accounts will earn a little bit more interest and usually have a pretty low threshold. They don’t often have a high deposit amount required to get access to them to get a little bit of interest. They might have a little bit of limitations when it comes to flexibility. You might be limited on how many withdrawals or deposits you could make each month. Make sure you’re aware of what those limitations are. Take that into consideration when you plan how you’re going to work your cash flow. It’s probably the next step up from a checking account where you can earn a little bit on your funds.
Kevin Zywna, Wealthway Financial Advisors: You still have a lot of liquidity in a basic savings account. But then some of them, many of them come with some restrictions on how frequently you can access that money. A lot of time, it’s six withdrawals in a monthly time period. Whether that’s outright withdrawal from a teller window, from an ATM machine, or transferring from a savings account to a checking account to cover bills. You’re typically limited to six a month. So you get a little higher interest rate, but then there’s a little bit more of a restriction on how frequently you can access the cash. Six withdrawals is typically more than enough in any monthly period, if you’re using the account properly.
Allison Dubreuil, Wealthway Financial Advisors: A little bit of nuance here, you can often get better rates at banks that are online only because they don’t have as much overhead. If you’re choosing a brick and mortar bank, your rates might be lower naturally because they have more expenses. And you can sometimes get better rates when you consolidate all of your savings into one account and have a higher level versus spreading it around into a lot of buckets. But I’m a fan of the bucket strategy.
Kevin Zywna, Wealthway Financial Advisors: The fewer the buckets, the fewer the problems.
Allison Dubreuil, Wealthway Financial Advisors: Yes, and the better the rate apparently, but some people like me need buckets to achieve their goals.
Kevin Zywna, Wealthway Financial Advisors: Right. Well, then whatever works. That’s what’s most important. The next step up from a savings account, then would be a high yield bank account. And this can come in a variety of different forms or names, depending on the financial institution that you use. You usually get a higher rate of return than a checking or savings account, but it also comes with more restrictions. Typically, you’ll see a high yield bank account might have a minimum deposit, say of $5,000. So as long as you promise to keep at least $5,000 in there, then you get their preferred rate of return. Similar to the savings account, it usually also comes with some withdrawal or transfer restrictions. You can’t have unlimited access to the funds like you do your checking account. But that’s a trade-off that you make. For a little higher rate of return is a little bit lower transactional use, as well as committing to a minimum balance requirement gets you a higher rate of return.
Allison Dubreuil, Wealthway Financial Advisors: Yes, so these accounts often don’t come with an ATM card or they don’t have a free network of ATMs. You might have to transfer money electronically from this type of account to your checking account to get access to the funds. But again, it’s designed for longer term savings that you’re hopefully not accessing on a regular basis so you can enjoy that higher interest.
Kevin Zywna, Wealthway Financial Advisors: All right, we’re going to pause right here going to take a break for the news, then we’re going to jump into some more bank type of accounts, that still very safe, still very liquid. But you can maybe earn a little bit more interest than what you have in the past certainly what you’re earning on your, your checking account these days, as I said earlier, we’re probably seeing in the range of 4% to 5% on some of these accounts, which is not a bad deal if you’re willing to conform to some of the restrictions and some of the minimum deposit levels in these accounts.
Kevin Zywna, Wealthway Financial Advisors: The higher the interest rate from a bank product standpoint, the more restrictions come with it. You give up a little ease of access, but in exchange you get a little higher rate of return. We went from checking to savings to high yield bank accounts. High yield bank accounts typically put some hurdles in front of you. For some people, that’s a good thing. You have to kind of go into a branch usually and request from a teller or a live human being a money transfer out of these accounts. They typically do not come with an ATM card or a checkbook to write checks out of so there are a little bit more restrictions to get a little higher rate of return there. Then another bank product that we see used a fair amount is a bank money market account. FDIC insured stable value does come with the usually some access to it either via a website, or phone transfer system, that type of thing. But then usually with a minimum deposit size of five or $10,000, something like that, you promised to keep that amount of money at least. And then in exchange, you earn a little bit higher interest rate on a money market deposit account.
Allison Dubreuil, Wealthway Financial Advisors: Yes, we like these. They’re kind of like a hybrid between a checking and a savings account, but with higher interest rates than you can get on a traditional savings account. If you have, let’s say, one month of living expenses in your checking account, and then you really have you know, solid income, don’t expect to need to access your emergency reserves anytime soon, then a money market is a really good option. You definitely have higher interest and still some flexibility with it.
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Kevin Zywna, Wealthway Financial Advisors: And then from the money market, we would see probably CDs being your next logical option at a bank. CDs, certificates of deposit, are becoming a dinosaur with checking accounts, actual certificates of deposits.
Allison Dubreuil, Wealthway Financial Advisors: Oh, they’re talking paper. Yes.
Kevin Zywna, Wealthway Financial Advisors: They used to be first in banking. There was an actual certificate, I do remember that. That was typed up and looks a little bit like a stock certificate. You promised to give the bank $5,000. And they usually come in different terms of six months, a year, 18 months, two years, three years, five years. You commit to leaving your money at the bank, in exchange for this certificate, and locking up a specific term, and earn a higher rate of return. These are typically the highest rates of return that you can earn from bank products. But in exchange, because comes that illiquidity.
Allison Dubreuil, Wealthway Financial Advisors: Right. If you withdraw your funds before the maturity date, then you pay a penalty. And the penalty amount will depend on your specific CD and when you make the withdrawal, but they really aren’t designed for people that are going to need to cash them out early. We get a lot of questions about CDs.The CD rates right now are I think up in the fives, yes, near five, it depends on the term. Generally, we still like a shorter term CD, just to not lock yourself into an interest rate for the next five years, because we are still seeing movement in interest rates.
Kevin Zywna, Wealthway Financial Advisors: Yes. And keep in mind, our view on bank savings is this should be your most accessible most liquid form of money. Like Alison laid out from the beginning, this is where the emergency fund money is capped, and then anything above that, that you’re going to use in a short term nature, so anything with the next one to two years, so you’ve got a big trip planned. If you have home remodel projects, do you need that cash to be close at hand liquid and accessible, all that falls under the bank products of a checking account savings account, high yield bank account or money market deposit account and certificates of deposit.
If I were if I were to design it properly, where you have your full complement of emergency funds set up, you could keep maybe 1/3 of it in like checking and savings account, which are most liquid but earn you the least maybe a third of it, in a money market type of deposit account at the bank. And then another third, which can be a little bit longer range six months to a year, you might be able to commit to a CD, a CD for that amount of time and earn yourself a higher rate of return. Knowing that you have the other two buckets to draw from first and there’s a low probability you’d have to cash in that CD before the maturity.
Allison Dubreuil, Wealthway Financial Advisors: I guess it depends on your definition of emergency which varies very widely. One other option for cash is to hold cash in a money market that’s a traded money market that’s actually in your investment account. So everything we’ve covered so far has been At the bank, FDIC insured, but there are other cash options that operate like cash but are traded.
Kevin Zywna, Wealthway Financial Advisors: And are outside of a bank and do not have FDIC insurance protection, but they are historically still very liquid and very safe. Money market instruments, what you would call a money market fund or a money market mutual fund. You would purchase these through all the major brokerages and investment companies. Vanguard has a suite of money market funds, Schwab, AmeriTrade, TD Ameritrade, Fidelity, large mutual fund companies, T Rowe Price, American funds all have their version of a traded mutual fund. You have to make a conscious decision. Unlike your bank, where the checking account or a savings account is the default, in a brokerage account, usually has a bank savings account as the default account that captures incoming and outgoing cash, you would purchase these money market funds, much like you would purchase a mutual fund. However you would trade to buy mutual funds, that’s how you would buy these money market funds. Their goal is to keep the value of a share at $1. Except for some very brief crises points in times, one of them being the housing crisis of 2008/2009 where a couple of money market funds did break the buck, it was called and they traded below $1 slightly and briefly in time. Yes, right. It would have been non-impact if you stuck it out. But they typically trade at $1. And then each month they pay out an interest rate. Now these money market funds, take your money and then they invest in other short, safe short term vehicles like other bank CDs, short term government securities, and then the interest that those vehicles throw off gets passed on to you, the holder of the money market fund. Those we’re seeing squarely in the four and a half percent rates of return right now.
Allison Dubreuil, Wealthway Financial Advisors: I like this idea for people and you know who you are, everybody knows themselves. I like this for people that have trouble keeping money in the bank. I mean, some people, if they have money in the bank, they will spend it and that’s okay, if that’s you and you know, that’s you. This is a way you could build up cash that’s not as accessible it just feels like you have to jump through hoops because you have to go to your broker or your maybe investment advisor or log on to your investment account it just feels like a bigger deal to touch that money. And so that can kind of put another roadblock between you and the cash that you’re trying to keep on hand versus keeping it at the bank.
Kevin Zywna, Wealthway Financial Advisors: Yes, psychologically it feels like it’s a little further away because the position traded money market fund trades like a mutual fund doesn’t behave like a mutual fund. It trades like one. That little bit of extra hurdle can be just enough of a psychological barrier to make sure that you don’t touch that money except for real emergencies.
Allison Dubreuil, Wealthway Financial Advisors: Tonight we’re talking about what to do with the cash? Yes. Well, what you need to do is assess how much access you need to it, how much interest you want to earn, what kind of service you’re looking for, and what kind of penalties you are willing to sacrifice depending on the product. We talked about basic bank products like checking accounts, which aren’t going to pay much of anything, savings accounts, high yield savings accounts, money markets and CDs. So those are your typical FDIC bank insured products.
Kevin Zywna, Wealthway Financial Advisors: And I suppose I should throw in a plug there for credit unions as well. While we’re talking in the bank language, a lot of this all applies to credit unions as well. You get PIC and NCUA. NCUA is the federal insurance program that protects bank savings deposits, similar to the FDIC insurance, so just a different program, but same protections, safe money.
Allison Dubreuil, Wealthway Financial Advisors: And on the note of FDIC or NCUA. If you have concerns about that, we talked about that in our last show. You could go on our website or wherever you get your podcasts and listen to our thoughts on the bank crisis and FDIC insurance.
All right, moving on switching gears a little bit, we do get a lot of questions about bonds. And there are various types of bonds. And I think there are a lot of people out there that still think of bonds as a possible safehaven for their cash needs.
Kevin Zywna, Wealthway Financial Advisors: Yes, and we would say no, that in most cases, a bond type of purchase, whether it be an individual bond or a bond fund is not the ideal place for cash instruments. Because while you can purchase individual bonds, be they government bonds, municipal bonds, or corporate bonds, and there’s a high certainly with government bonds, there’s a near perfect certainty, you are going to get your money back with interest. While you hold that bond, the price of the bond fluctuates. And what we would not want to have happen is that you have to sell that bond at an inopportune point in time in order to return the principal back to you. And that’s one of the risks that you take when investing in an individual bond or similarly in a bond fund on a daily basis or bond ETF exchange traded fund. The ETS will fluctuate throughout the course of the day. They do fluctuate. The point of cash is to protect your cash from those short term market movements. And that’s why in most cases, we don’t think bonds are an ideal vehicle for what we would earmark your cash, your emergency fund savings, and your short term cash needs.
Allison Dubreuil, Wealthway Financial Advisors: Specifically, we get a lot of questions these days about I bonds. I bonds are all the rage and in the news because they’re paying a pretty significant interest rate above and beyond what you can get in the bank. They are limited in the amount you can purchase. It’s $10,000 per person that can be purchased. While they are exempt from state and local taxes, you do have to hold the bond for at least five years or there will be a penalty. So again, it’s a longer hold period.
Kevin Zywna, Wealthway Financial Advisors: Right so illiquid, for most intents and purposes, that you can only get your money back when you pay a penalty. Five years is actually considered a medium to long hold period. That’s not an ideal use for your cash now $10,000 in the whole scheme of things may not be a huge number to move the needle, but still, this would fall out of the purview from CAC.
Allison Dubreuil, Wealthway Financial Advisors: Here’s why we say that about that five year period. With I bonds the interest rate adjusts every six months. You purchase it at, say 7- 8%, whatever it was paying the past six months, but that’s going to adjust. And so that’s the risk in holding it longer.
Kevin Zywna, Wealthway Financial Advisors: Along those lines, while I bonds are kind of the most popular right now and the most accessible to people, you can just purchase a government bond, government T bill, a one year T bill is paying 4.5%, approximately. You hold it for one year, you will get 4.5% return. Interestingly, longer maturities of government bonds now are paying less than that. It’s called an inverted year yield curve. We’re not going to get into the complexity of that right now, but a three year treasury bill 3.9%, five year 3.7% and the 10 year 3.6% approximately are the rates that they’re paying. While you can get some higher interest rates out of those safe government bonds, you will subject yourself to short term movements, evaluation of those bonds or those bond funds. And it’s really not necessary when a lot of times in bank products right now, you can get 4 or 5%, especially with online bank accounts. If you’re comfortable doing that. That’s where you find some of the highest rates of return.
Allison Dubreuil, Wealthway Financial Advisors: Right? So emergency bank money, keep in the bank, everything else. Our philosophy is invest it for long term growth. If you’re an investor, hopefully you’re going to be an investor for the rest of your life. And very long term growth oriented investing has not as much risk as people perceive it does as in the short term.
Kevin Zywna, Wealthway Financial Advisors: Right. There’s very little risk in having less money in your investment accounts, if done properly, if you’re going to hold it for 10 years or longer. That’s a long time horizon. We could get into that in more detail, but we’re running out of time here.
Director of Financial Planning