In last week’s blog, Managing Debt as Interest Rates Rise, Garry reminded us of some fundamental decision-making regarding debt payoff versus seizing the opportunity to get meaningful interest rates on our cash accounts, or “safe money.” Let’s agree to define cash accounts as money markets, high-yield savings, and CDs. Today’s blog post will discuss the fallacy of “falling in love” with these cash accounts.
We begin today’s discussion by looking back for perspective. In 2007, interest rates were at a level like what they are today. (You read that correctly! It has been 16–17 years since we were able to get the interest-rate yields we are currently enjoying in our cash accounts.) What happened in the interim was one of the longest, and lowest, interest rate environments ever recorded. I’m sure you remember it well!
Herein lies the problem: With 4–5% interest-rate yields available in cash accounts, excess money that should really be invested for long-term planning is simply “parked” in these accounts. It’s comfortable and the path of least resistance! However, we understand that it is not the best investment advice. If we fall in love with our cash accounts, two outcomes become probable. First, interest rates will eventually decline, reducing our yields on these accounts. (The initial interest rate cuts in this cycle are likely to begin within the next several weeks!) Secondly, without initiative, assets that should be invested for long-term goals will simply remain “parked” in cash accounts, possibly for a long time. As interest rates decline and the gap between meaningful market returns and cash account interest rates grows wider over time, you may not experience the potential asset growth you could have achieved. In our financial planning world, we call this Opportunity Risk—missing out on potential gains.
Now, to set the record straight, there is money that should remain in cash accounts, regardless of interest rate yields. Consider the following:
- Emergency Cash Reserves: For those still actively employed, 4–6 months of total household living expenses is appropriate. For those in retirement, this can stretch to 6–12 months of living expenses.
- Money set aside for specific uses within the next few years: Examples include funds for replacing a vehicle, home improvement projects, gifting to family, or charitable giving, to name a few.
Friends, the formula is simple: Keep your short-term money in short-term accounts (cash accounts, as outlined above) and keep your longer-term funds invested for the future.
What questions does this topic raise for you? Please contact us! We’d love to hear from you and discuss your individual financial situation and specific questions.
