Most experts will advise you to create an emergency fund first and foremost. Maybe even before paying off all your consumer debt. You may also be accumulating cash for a home down payment, a car, a future investment, or some other purpose. But where is the best place to keep your cash? The main factors to consider are safety, ease of access, and income generation. Luckily, you have several options.
You Can Keep Your Cash Inside Your Home
It is logical to have a relatively small portion of cash inside your home for everyday use and small emergencies. Such money can be placed anywhere in the home. It could be in a drawer, a shoe box, or under the proverbial “mattress”.
But the safest place to keep cash at home is inside a safe. This safe should be of medium size and weight. The bigger and heavier it is, the more difficult it will be for someone to walk away with it. It should also be waterproof and fireproof.
Finally, DO NOT lose your key or combination. Also make sure that other trusted family or household members can access the safe in case of an emergency.
A safe can also be used to store important documents. See Recordkeeping for Individuals – Can You Locate Key Documents? for more information.
A Safer Option Is To Keep Your Cash At The Bank
Keeping your cash at the bank is an even safer option. When you keep your cash at the bank, it is less likely to be lost or stolen. Not to mention that it can also allow you to make electronic transactions such as transfers and payments with ease.
Cash at the bank is typically in demand deposit accounts such as checking, savings, or money market accounts. Demand deposit accounts allow you to withdraw money at any time (“on demand”). You can also keep your cash in a time deposit account such as a certificate of deposit (CD). Here you cannot withdraw your money without penalty until the deposit matures.
This may all sound great, but what if your bank gets into financial trouble and fails? Although this is a relatively rare occurrence, it can happen from time to time. This is why the government created the FDIC.
Cash in the bank is generally protected by the Federal Deposit Insurance Corporation (FDIC). Most, but not all, banks are federally insured. So make sure you keep your cash in a federally insured bank.
FDIC insurance only covers deposit accounts at insured banks. This includes checking and savings accounts, money market deposit accounts, and certificates of deposit. FDIC insurance does not cover other investments you may purchase from your bank, such as annuities, money market funds, stocks, bonds, or mutual funds, for example.
The FDIC insurance limit is $250,000 per depositor, per insured bank, for each account ownership category. So a joint account with two co-owners will have total insurance protection up to $500,000 ($250,000 per co-owner).
Account ownership categories include single accounts, joint accounts, retirement accounts, trust accounts, etc.
Despite the FDIC protection, you should still look to keep your cash in a financially stable bank. The FDIC’s stated goal is to make insurance payments within “two business days of the failure of the insured institution”. But it can potentially take significantly longer.
Interest Income On Your Cash
There is another benefit when you keep your cash at the bank. It’s the potential to earn money on your principal. Yes, interest rates are very low these days, but something is better than nothing. Plus, many expect that they will eventually rise closer to more historical average levels.
The amount of interest you can earn from a bank is determined by several factors. Among them are:
- Market rates – Banks use depositor money to make loans and investments. The more the bank can earn from these investments and loans, the more they can pay their depositors.
- Level of access – Money that you can access more easily generally pays lower interest. This is because easier access makes it less certain for the bank that they will have the money available for their investment and loan purposes.
- Size of Account – You may be able to qualify for higher interest rate yields if you exceed certain account balance thresholds or minimums. Again, loaning the bank more money (via your deposits) may result in a reward via a higher interest rate.
So a checking account (unlimited access) will typically pay the least interest, while a certificate of deposit (restricted access) will pay relatively more.
Most of us have checking accounts at the bank. These are bank accounts from which we normally pay everyday expenses. This is usually done with actual physical checks, debit cards, and electronic checks.
So it is logical that you will keep some of your cash inside a checking account. However, this is not the ideal place for cash set aside for an emergency fund or future investment.
There are two key reasons for this. First, it is easier to spend extra cash sitting inside a checking account. Especially when the purpose of such an account is to spend for everyday living expenses.
Second, checking accounts typically do not pay interest. The few that do generally pay less than other deposit accounts.
Instead, it is better to earmark any extra cash by putting it inside one of the account types discussed below.
A savings accounts does not typically have check writing privileges. As such, you may be less likely to use funds in the account for everyday or spur of the moment expenses.
The bank also pays interest on the balance. But because the money is still available on demand via a withdrawal or online transfer, the interest rate is relatively low. Federal law limits the amount of withdrawals to six per monthly statement cycle. However, ATM and in-person withdrawals are not counted towards this limit.
Savings accounts also may have relatively low minimum balance requirements and maintenance fees than their money market counterparts.
So savings accounts may be a good fit for those just starting out with accumulating cash, and those with smaller account balances.
Keep in mind, however, that some savings accounts can and do pay just as much as money market accounts, if not more. However, such accounts typically require higher balances in order to gain access to the greater yields.
Money Market Deposit Account
These are deposit accounts which are very similar to savings accounts. The number of withdrawals per statement cycle are also limited to six. However, money market accounts generally allow you to write checks or use a debit card in utilizing these limited withdrawals.
Money market accounts also generally have higher minimum balance and deposit requirements than savings accounts. Banks also have more flexible use of money inside money market accounts. For example, in addition to making loans, they can also invest it in conservative investments such as treasury notes, commercial paper, certificates of deposit, etc.
In exchange for this flexibility to potentially earn more on your money, money market accounts on average pay a higher interest rate than savings accounts. However, there are some savings accounts which yield comparable and sometimes higher rates than money market accounts. Rates vary by institution, and are generally higher with online banks.
Online banks do not have the overhead costs of traditional brick-and-mortar institutions. As such, they can often afford to pay higher rates. The amount of money you keep in your account will also often affect your interest rate.
Money market accounts may be a good fit for those who have relatively higher balances in their accounts on a consistent basis, but who also want to be able to access the funds on demand. Meeting the minimum balance and deposit requirements allows you to qualify for the higher interest rate yields while avoiding maintenance and other fees.
Certificate of Deposit
If you want a higher interest rate, you may wish to put some money into a certificate of deposit (CD). A CD is a time deposit. You can earn a higher interest rate with a CD because the bank can count on using your money for a specified period of time.
The term of a CD can vary from a few months to several years. As with bonds, the longer the duration, the higher the interest rate paid.
If you withdraw money from a CD before it matures, you must pay a penalty. So make sure you only deposit money that you will likely not need before maturity.
Certificates of deposit may be a good fit for those who seek a higher interest rate yield and do not need access to the funds for a longer period of time. If you invest in CDs, you may want to consider establishing a CD “ladder” if you have enough funds to meet deposit minimums.
Laddering is when you split your funds up into CDs with varying maturities. This way you can invest in longer term instruments while also having some of your money available sooner. In this regard, the shortest “step” of your ladder may be money inside a savings or money market account.
Keep Your Cash Inside An Investment Account
Another safe place to keep your cash is inside an investment account. This is ideal for cash which you intend to invest at some point in publicly traded securities. You do have a few different options with the cash parked with your broker.
First, you can just leave it as cash within the account. This option will earn some interest similar to a savings or money market deposit account. The actual yield will vary by broker.
Some brokers have deposit programs where they deposit your money in FDIC insured banks. As such, not only is your money FDIC insured, but the applicable limits may be much greater if money is deposited at multiple banks.
But you can also choose to keep your cash in short term fixed income investment vehicles such as money market funds, brokered CDs, or treasury bills.
Again, this all sounds good, but what if your broker gets into financial trouble and fails? This is why SIPC insurance exists.
Securities Investor Protection Corporation (SIPC) membership and insurance is generally required for all brokerage firms registered with the Securities and Exchange Commission (SEC). SIPC insurance will protect your investments up to a specified limit if your broker were to become insolvent. Limited coverage may also be provided for losses due to unauthorized trading or theft.
SIPC insurance covers most types of investments in your account. This includes stocks, bonds, mutual funds, ETFs, CDs, and other registered securities. However, unregistered securities such as certain partnership interests, and commodity futures contracts or options may not be covered. Cash involved in foreign currency exchange trades is not covered.
The SIPC coverage limit is $500,000 per customer. Up to $250,000 of this amount can cover cash in your account. If you have multiple accounts with a brokerage firm, “separate capacity” is used to determine protection.
Separate capacities include individual accounts, joint accounts, corporate accounts, trust accounts, IRAs, Roth IRAs, etc. So each of these types of accounts will have protection up to the aforementioned limits.
Make sure to only invest via SIPC member brokerage firms. It is also important to understand that SIPC insurance does NOT protect you from the loss in value of your investments.
Money Market Funds
These are mutual funds which invest in high quality and very short term investments. Examples include treasury bills, negotiable CDs, commercial paper, banker’s acceptances, repurchase agreements, and eurodollar CDs.
The goal of the investment managers of such funds is to attain a relatively attractive yield while maintaining the per share net asset value (NAV) at $1. Although it is theoretically possible to lose money in such funds, it is relatively rare.
These funds offer interest rate yields that can often be higher than those of savings or money market deposit accounts. However, there are usually minimum balances and fees to consider. Unlike other mutual funds, money market funds generally do not have load (commission) fees. Some fund managers even waive part of their operating fees (expense ratio) due to low current yields.
Check writing and other withdrawal capabilities are also generally available. The six withdrawal limit which restricts savings and money market deposit accounts does not apply to such funds. But there may be some restrictions. Make sure to look at each fund’s prospectus for specifics before investing.
Money market funds are considered investments, and not cash. As such, they are generally covered under SIPC insurance rather than FDIC.
These funds may be a good fit for money you are waiting to invest in riskier securities such as equities and longer duration fixed income investments.
Tax Exempt (Municipal) Money Market Funds
“Municipal” money market funds invest in local municipal short term government debt. As such, the dividends (interest) they generate is tax free on your federal income tax return.
However, keep in mind that certain such funds may create an Alternative Minimum Tax adjustment. However, this will not impact most taxpayers.
Also, the interest generated by municipal bonds may be (at least partly) taxable for income tax purposes by your state. If you happen to live in one of the few states without an income tax, they will not be an issue for you.
Most states only exempt from income tax interest income originating from obligations of the federal government (treasuries), and their own state debt.
Certificates of Deposit Via Your Broker
You can also buy a CD from your broker. These are generally bank CDs sold by a broker. They are generally FDIC insured since they are mostly time deposits. Some, however, may be securities, and instead are covered under SIPC. As such, you may be able to sell them on the secondary market before maturity.
However, in doing so, you may lose part of your principal due to market risk (interest rate fluctuations from the time you purchased the CD). Not to mention you may also pay broker commissions or fees.
Durations and minimums of brokered CDs may also be higher than CDs you may purchase at a bank. The broker may also charge a fee for selling the investment to you. However, due to the larger selection of products, you may be able to earn a higher yield from a CD obtained through a broker.
Keep in mind, though, that to get the FDIC protection, the bank that issues the CD must be insured. Also, if the CD is from another bank in which you already have cash deposits, you may possibly exceed your FDIC limits with the CD.
As discussed above, certificates of deposit are for those who don’t mind locking up their money for a longer period of time in exchange for a higher yield.
Treasury bills are very short term (one year or less) debt obligations of the U.S. Government. Their duration can be as little as a few days (cash management bills). However, the most common terms are one, three, six and twelve months.
Other government debt obligations such as notes and bonds typically pay interest every six months since they have longer maturities. However, with T-bills, you purchase them at a discount to their face value. The difference is your interest (at maturity).
Treasury bills are quoted based on their annualized interest rate. The minimum investment for such instruments is very low. They are also very “liquid” in that they can be sold easily prior to maturity. Doing so, however, may prevent you from getting your exact initial principal back (market risk).
However, due to their short duration, any change in market interest rates would have a relatively small market risk effect on T-bill prices. Similar to CDs, it’s best not to invest in a T Bill with a duration longer than when you think you may need the money.
Due to their safety and flexibility, treasury bills may offer lower yields than comparable term investments such as CDs.
T-bills may be a good fit for those with smaller cash balances due to their low minimums and minimal fees if any. Especially if you buy direct (see below). They can also be an attractive option for keeping money you are waiting to invest in riskier securities.
Finally, interest from treasury securities is tax-exempt for state income tax purposes. This can be a valuable benefit if the interest is significant and your resident state imposes an income tax.
You Can Buy Treasury Bills Directly From The Government
Note that you can also buy (newly issued) treasury bills directly from the government via TreasuryDirect. The minimum investment can be as low as $100. However, brokers can have their own minimums, which usually are no more than $1,000.
Treasury securities such as t-bills are arguably the safest place to keep your cash. They are backed by the full faith and credit of the U.S. government. As such, you do not need FDIC or SIPC protection for such securities if they are purchased directly as indicated above. This way, you also do not have to use up your SIPC protection by keeping them in “street name” with a broker. Of course, this is only an issue for larger accounts.
You should aim to keep your cash safe and easily accessible. Minimizing or avoiding any bank fees, and maximizing your interest income yield are also smart moves.
The interest offered on any account or fund will vary among financial institutions. Online banks often offer relatively higher yields due to their lower overhead.
Also, many accounts have deposit minimums. So a little research and comparison shopping may be worth the effort in deciding where to keep your cash.