Can your cash be doing more?

Higher interest rates mean you are paying more to borrow money – as anyone who has thought about buying a home, financing a major purchase or getting a new credit card knows. But what if you are a saver, not a borrower? Then higher interest rates can actually work in your favor – if you have a strategy.

After years of low yields (the interest rates paid on savings accounts, CDs, Money Market Funds, etc.), savers now stand to see better returns on their cash reserves than they have in years. This is because the Federal Reserve had been raising its target interest rate since March 2022. While the Fed's target rate doesn‘t directly change the rates on your accounts, there's a ripple effect that leads to institutions offering far better yields. And with inflation taking a bite out of your purchasing power, it's more important than ever to make sure your cash reserves are earning as much as possible for you.

That's why it's time to start shopping for better rates.

A WORD ABOUT CASH RESERVES

The amount you should keep in cash reserves depends on two factors: your monthly expenses and the stability of your income. You should also consider whether you have any large one-time expenses coming up, such as a vacation, a new car or a wedding to pay for.

All told, your cash reserves should equal somewhere between six and 24 months' worth of spending, depending on how stable your income is.

Your cash reserves should provide you with quick and easy access to your money – otherwise known as liquidity. You want to be able to draw funds without a waiting period, and with minimal taxes or fees. With that in mind, let's look at the options for higher-yielding accounts.

Money Market Funds

A Money Market Fund generally offers better rates than a regular savings bank. Rates can vary widely, though, with an average rate between 0.01% and 4.25% annual percentage yield (as of November 2024), depending on your balance. Money markets require a higher initial deposit, but many banks offer a linked account with your checking, and often for a lower fee.

High yield savings accounts

As of November 2024, a high-yield savings account can earn around 4% APY compared to just 0.4%, the average rate on regular savings accounts. High-yield savings accounts often require a higher starting balance, are federally insured up to $250,000 per depositor, and should provide easy access to your funds for a reasonable fee. Don't forget online options – these often offer better APY and lower fees than traditional banks.

Certificates of Deposit

Unlike regular savings accounts, most CDs have fixed rates, so you can lock in a higher rate while it lasts. If you have a low-interest CD coming due, this higher-interest-rate environment is a good opportunity to boost your potential yield by switching into a new CD with a higher rate. Unlike high-yield savings accounts and most Money Market Funds, you can't touch the money for the duration of the term, so it's important that you think carefully about how much money you can set aside for that length of time. Keep an eye out for minimum deposit requirements and any penalties for early withdrawal. And remember, anything with a maturity of more than one year doesn't count as a cash equivalent.

Where not to keep cash reserves

There are some investments that you should not consider to be "cash equivalents," because either they take too long to provide access to your money, or the fees and penalties can be prohibitive and end up costing you money. These include CDs with terms of longer than 12 months, U.S. Treasury notes and bonds – not because they're not good investments, but because the time to maturity (two to 10 years for notes and 10 years or longer for bonds) is too long for them to count as cash equivalents. Life insurance cash values are not suitable for use as reserves either, because of potentially large surrender penalties, tax risks and other restrictions.

FINAL TIPS

No matter which higher yielding account you set up, there are two general rules to keep in mind: 

1. Always check the FDIC-insured amount. Limits set by the FDIC are for each depositor, not each separate account, so keep an eye on your total assets held by any one institution. 
2. Add a beneficiary to your accounts. Be sure to ask for and fill out a Payable on Death form for your accounts, so they automatically pass to your beneficiary and won't end up in probate.