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Investors Should Now Be Earning At Least 2% On Their Cash

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Photographer: Andrew Harrer/Bloomberg

Cash likely plays an important role in your investment portfolio. Cash provides liquidity and reduces volatility. Asset allocation models differ, but cash allocations can often be 15% or higher for some portfolios.

The returns generated by cash, when protected by FDIC insurance, can be considered risk-free. You can use this risk-free return as a basis of comparison for other investment opportunities. For example, if you can earn 2.20% on a 12-month CD that is FDIC insured, why would you invest in a bond fund that promises a 2.20% yield? With the CD, your money would be FDIC insured. With the bond fund, you would be taking credit and market risk. In this example, the bond fund offers incremental risk without incremental return: a bad deal.

In 2018, volatility has returned and interest rates are increasing. However, there is a divergence between interest rates at traditional banks and interest rates paid by internet-only banks. Traditional banks are still paying close to 0% on savings accounts. For example, Bank of America is paying 0.03% APY on basic savings accounts and 0.06% APY on savings accounts for people with bigger balances. Online banks are paying much higher rates. MagnifyMoney (where I work, which is owned by LendingTree) updates its rankings of the best online savings accounts and CDs daily. Today, you can easily earn 1.70% or higher from a savings account and 2.20% APY on a 12-month CD. If you are earning close to 0% on the cash in your portfolio, you will be facing two major issues:

  1. You will be losing out on easy money. If your retirement portfolio has $1,000,000 and 10% is allocated to cash, you could earn more than $2,200 with a 2.20% APY CD (from a provider like Marcus) or $50 from Bank of America (which pays only 0.05% on a 12-month CD). The difference is material.
  2. You will be inclined to take more risk than needed, because you will consider your risk-free rate to be closer to 0%. Suddenly, a bond fund generating 2% look appealing in your fixed income portfolio, when it might not look attractive compared to the rate offered by an online bank.

Put simply: by not earning enough on your cash deposits, you are giving up money today and will be tempted to take more risk than needed. Here are some easy way to ensure you get the best yield on your cash:

  • Ask your banker or broker: As interest rates increase, pricing is becoming less transparent. Banks sometimes have special deals or promotions that aren’t advertised. Tell your banker or broker that you can get 2% online, and ask them to meet or beat that rate. But be prepared to move your money if you can’t get a good interest rate.
  • Open an account directly with an online bank: Big names are now entering the online savings market. Companies like Goldman Sachs (via Marcus), Ally, Barclays and Synchrony are investing heavily in their digital storefront. These are all publicly traded companies offering top tier rates online. Opening an account only takes a few minutes with all of these institutions.
  • Shop for brokered CDs: Most online brokerage accounts offer access to the broker CD market. Over the last year, rates have become increasingly competitive in the broker market. You will likely be able to buy the CDs online through your brokerage account, making it easy to keep track of all accounts in one place.

Just remember: your deposits are protected by the FDIC so long as you stay within the limits. You can find answers to frequently asked questions about deposit insurance on the FDIC website.

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Photographer: Andrew Harrer/Bloomberg

Cash likely plays an important role in your investment portfolio. Cash provides liquidity and reduces volatility. Asset allocation models differ, but cash allocations can often be 15% or higher for some portfolios.

The returns generated by cash, when protected by FDIC insurance, can be considered risk-free. You can use this risk-free return as a basis of comparison for other investment opportunities. For example, if you can earn 2.20% on a 12-month CD that is FDIC insured, why would you invest in a bond fund that promises a 2.20% yield? With the CD, your money would be FDIC insured. With the bond fund, you would be taking credit and market risk. In this example, the bond fund offers incremental risk without incremental return: a bad deal.

In 2018, volatility has returned and interest rates are increasing. However, there is a divergence between interest rates at traditional banks and interest rates paid by internet-only banks. Traditional banks are still paying close to 0% on savings accounts. For example, Bank of America is paying 0.03% APY on basic savings accounts and 0.06% APY on savings accounts for people with bigger balances. Online banks are paying much higher rates. MagnifyMoney (where I work, which is owned by LendingTree) updates its rankings of the best online savings accounts and CDs daily. Today, you can easily earn 1.70% or higher from a savings account and 2.20% APY on a 12-month CD. If you are earning close to 0% on the cash in your portfolio, you will be facing two major issues:

  1. You will be losing out on easy money. If your retirement portfolio has $1,000,000 and 10% is allocated to cash, you could earn more than $2,200 with a 2.20% APY CD (from a provider like Marcus) or $50 from Bank of America (which pays only 0.05% on a 12-month CD). The difference is material.
  2. You will be inclined to take more risk than needed, because you will consider your risk-free rate to be closer to 0%. Suddenly, a bond fund generating 2% look appealing in your fixed income portfolio, when it might not look attractive compared to the rate offered by an online bank.

Put simply: by not earning enough on your cash deposits, you are giving up money today and will be tempted to take more risk than needed. Here are some easy way to ensure you get the best yield on your cash:

  • Ask your banker or broker: As interest rates increase, pricing is becoming less transparent. Banks sometimes have special deals or promotions that aren’t advertised. Tell your banker or broker that you can get 2% online, and ask them to meet or beat that rate. But be prepared to move your money if you can’t get a good interest rate.
  • Open an account directly with an online bank: Big names are now entering the online savings market. Companies like Goldman Sachs (via Marcus), Ally, Barclays and Synchrony are investing heavily in their digital storefront. These are all publicly traded companies offering top tier rates online. Opening an account only takes a few minutes with all of these institutions.
  • Shop for brokered CDs: Most online brokerage accounts offer access to the broker CD market. Over the last year, rates have become increasingly competitive in the broker market. You will likely be able to buy the CDs online through your brokerage account, making it easy to keep track of all accounts in one place.

Just remember: your deposits are protected by the FDIC so long as you stay within the limits. You can find answers to frequently asked questions about deposit insurance on the FDIC website.

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Nick Clements is the Co-Founder of MagnifyMoney.com, a personal finance website that was acquired by LendingTree in 2017.

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Nick Clements is the Co-Founder of MagnifyMoney.com, a personal finance website that was acquired by LendingTree in 2017.