Where’s the Best Place to Stash Your Cash?

Key Takeaways

• Cash investments can be anything from literal cash to money in your checking account to vehicles that pay you some level of interest.
• Cash won’t gain in value, but it won’t necessarily decline in value, either.
• Cash investments are sometimes described as risk-free, but they do have a major risk: inflation.
• You want to consider whatever interest rate or yield that you’re able to earn on your money, liquidity needs, and safety.
• Certificates of deposit are good high-yield investments, but can be limited in terms of liquidity and complexity.
• Money market mutual funds have been pretty safe despite not being FDIC-insured, but there are considerations to keep in mind.
• Brokerage sweep accounts can be a drag on your returns.
• Yields have come up, which has tax implications for cash investments.

Margaret Giles: Hi, I’m Margaret Giles from Morningstar. Yields on cash-type investments have come down as the Federal Reserve has cut interest rates, but they’re still positive on an inflation-adjusted basis. Joining me to discuss what investors should think about as they assess different cash options is Christine Benz. She’s the director of personal finance and retirement planning at Morningstar. Christine, thanks for being here.

Christine Benz: Margaret, great to see you.

What Are Cash Investments?

Giles: Before we dive into specific vehicles, what do we mean by cash investments, and what role do they serve?

Benz: It’s a bit of a head-scratcher. I remember when I started in investments at Morningstar, I was like, “Cash? What?” And really, there’s a broad range. It can mean anything from cash in your pocket, literal cash, to money in your checking account, to vehicles that do pay you some level of interest. But the unifying theme is that your cash investments won’t gain in value, but they won’t necessarily decline in value either. That’s a unifying theme across all different cash accounts, but generally, liquid accounts that you can tap at any time.

Inflation Risk of Cash Investments

Giles: Cash investments are sometimes described as risk-free, but they do court a major risk. What is it?

Benz: It’s inflation risk, and, you know, I sometimes think that investors underrate this inflation risk. And certainly today, you can earn a higher yield on cash investments that is above the inflation rate. But at other points in time, especially that long stretch we had where cash yields were very, very low and inflation was at least a bit over the cash yields, that cash was kind of dead money or actually worse for investors. You want to be careful not to overdo the peace of mind that comes with that principal stability because inflation is taking a little bite out of your principal along the way.

3 Considerations for Cash Investments

Giles: You think there are three main considerations when it comes to looking at cash investments. What are they?

Benz: The main one would obviously be whatever interest rate or yield that you’re able to earn on your money, that is kind of the attention hog in this discussion. It’s the main thing people look for. It’s important, the higher the better, ideally. But you also want to bear in mind liquidity, how ready access would be to your funds when you needed them. Most of us hold cash because we are holding it for unanticipated expenses, or we have knowable short-term expenses. We really need the money to be liquid. Typically, there’s a trade-off with cash investments, where things like certificates of deposit will pay you a higher yield, but in exchange for having to lock up your funds for a period of time. And some types of cash investments just make sure that you keep a minimum investment in place in order to earn the full yield or in order to avoid fees on that account. You want to keep in mind liquidity and how much you need to have in the account.

And then finally, safety is the other key component that you’d want to bear in mind. Most cash-type investments, certificates of deposit, money market accounts through a bank, high-yield savings accounts, those will be FDIC-insured up to the FDIC’s limits. But money market mutual funds are a notable carve-out. They are not backed by FDIC, so it’s important to understand that you often will earn a higher yield on a money market mutual fund and certainly have that convenience of having your funds sit by side by side with your investment accounts, but you do not have those FDIC protections.

Giles: It’s not just about chasing yield.

Benz: Don’t limit your due diligence to just what has the higher yield today.

Limitations of Certificates of Deposit

Giles: You mentioned that those certificates of deposit are some of the best-yielding options on offer today. When are they not a good fit?

Benz: If you have ongoing liquidity needs from your portfolio, I would say that’s one limitation of CDs. You are typically required to keep your money in the certificate of deposit for a specific maturity. If you need to crack into it early, you will surrender a portion of your interest. It’s important to understand what the strictures around the CDs are. And then I would say, another sort of side note on CDs, especially these sorts of laddered groups of CDs that a lot of people hold, it just can get complicated to manage them as time goes by, so you’d want to keep that in mind as well.

Are Money Market Mutual Funds Safe Investments?

Giles: Money market mutual funds aren’t FDIC-insured, like you mentioned. Do you see that as a major drawback?

Benz: From a practical standpoint, money market mutual funds have been pretty safe. There was a notable exception during the great financial crisis, where a very large money market mutual fund did what’s called broke the buck. It meant that its net asset value dropped below a dollar, and so shareholders in the fund weren’t necessarily made whole. Very, very rare. Since the great financial crisis, we have seen some tightening up on the rules around how money market funds are managed, so in general, they are safer than they once were. And then another thing I would say is if you are with a very large investment provider, there’s a lot of reputational risk riding on keeping that money market fund in good standing on maintaining that stable net asset value. I would say if you’re with one of the bigger players, that should provide you with some peace of mind.

And then another thing to keep in mind is it depends on what the money market mutual fund invests in. If it’s a money market Treasury fund, it is going to have to invest the bulk of its assets in Treasury securities, which in turn are backed by the full faith and credit of the US Treasury, the US government. To me, that is a good safeguard for money market mutual funds, mutual fund investors who are worried about the fact that they’re not getting that FDIC protection. Pay attention to what that money market fund is investing in.

Why Investors Should Be Cautious of Brokerage Sweep Accounts

Giles: Brokerage sweep accounts are actually a type of cash investment that you caution investors against. Why is that?

Benz: They’re convenient, so this is an account type that sits side by side with your investment accounts, and if you have uninvested funds, they will typically go into this brokerage sweep account. These are notoriously low-yielding accounts, so they’re great moneymakers for investment providers, but for investors, they can be a real drag on your returns. You want to be careful to not have too much sitting in one of these brokerage sweep accounts, especially if your investment provider is a bit stingy with the yield, and many of them are.

Tax Implications for Cash Investments

Giles: I know I’m certainly guilty of that sometimes. Finally, you think it’s important to bear the tax considerations in mind when thinking about those cash investments. So what should investors do to manage those tax implications?

Benz: Yields have come up. They’ve come down a little bit recently on various cash accounts, and so you do want to bear in mind the tax implications. You’ll pay tax typically at your ordinary income tax rate, provided that you are holding the cash investment inside of some sort of a taxable account. If you are a high-tax bracket person, maybe over the, say, 24% tax bracket, you’d want to be careful to think about the tax implications and perhaps holding a municipal money market fund in lieu of a taxable one in an effort to help limit the tax drag on the account. Bear that in mind, especially if you’re a higher-income tax-bracket person.

Giles: Thanks, Christine. Helpful to have context about these different types of cash. Thanks for taking the time.

Benz: Thank you so much, Margaret.

Giles: I’m Margaret Giles with Morningstar. Thanks for watching.

Watch What You Should Know About Backdoor IRAs for more from Christine Benz and Margaret Giles.