While many people do not think of cash as an investment, it is often a substantial portion of your financial portfolio. Whether accumulated in checking or savings accounts or certificates of deposit (CDs), you should make sure your money is working in the most effective way possible. Earning competitive returns on your cash investments should be part of your overall financial strategy.
Here are some thoughts to keep in mind as you create a plan for your cash investments:
- Liquidity and activity levels usually influence the interest rates offered on different types of cash accounts.
- Liquidity means how quickly you can access your funds.
- Activity means how often you can use the account.
- Generally, accounts that allow more liquidity and more activity pay lower interest rates.
A checking account, which provides convenient access to your money, usually pays lower interest rates than a savings account that limits the number of monthly transactions. With a CD, you commit your funds for a certain term and earn higher interest rates. CD terms typically range from three months to five years with the longest maturity CD usually paying the highest rate. However, CDs do not allow for early access without an interest penalty.
Choosing the best account, or combination of accounts, depends on how you use your cash. You may want to consider a strategy that combines two or three accounts for your particular cash needs. For example, most people have just two accounts: checking for regular monthly expenses and savings for major expenses (a vacation, a new car, a down payment on a house) or unexpected expenses. On the surface, it may seem wise to put the bulk of your cash in your savings account where it typically earns higher interest than in your checking account.
On closer examination; however, it would be wiser to add some short-term CDs to the mix. You would also want to reduce your checking balance to a minimum comfortable enough to cover regular expenses, and use your savings account as a source of funds for emergencies only. The remaining cash could be placed in short-term CDs with staggered maturity rates (e.g., 3-month, 6-month or 1-year) and used as longer-term accumulation accounts.
Such a strategy allows you to earn higher interest rates than with a savings account alone. And it still gives you access to your funds for making that major purchase at year’s end.
Of course, you have to pay attention to the features of the accounts you choose for your cash investments. By taking into consideration how you use your money, however, you can improve the returns and possibly make that major purchase a little sooner.