First, a little Economics 101 refresher on cash. The term “cash” is most often associated with the aforementioned traditional checking and savings accounts found at banks. In broader terms, cash and cash equivalents refers to many types of investments that are highly liquid and can easily be converted into cash used to buy and sell everyday items. Liquidity (the ease with which an asset can be converted into cash) is the defining characteristic of each type of cash and cash equivalent. As with any investment, there are cost/benefit trade-offs between various cash vehicles outlined below. Let’s look at four types along with Treasury I Savings Bonds.

Interest bearing savings accounts found at banks and credit unions are the next most liquid type of cash investment. Transactions (with the exception of some that allow electronic transactions and check writing) cannot be conducted from savings accounts. Depending on the account type and institution, there may be limits on the number of transfers that can occur monthly (e.g. 6). In order to compensate for this loss of liquidity, savers are compensated by earning higher yields and more interest on these funds. FDIC insured.

Money Market Mutual Funds are cash-like investments held inside investment accounts such as individual brokerage accounts and retirement accounts. MM mutual funds are intended to preserve principal by maintaining a value of $1 and earning interest. In order to do so they buy ultra short term debt securities such as treasury T-bills and commercial paper and pass on the interest to shareholders. As such, depending on the interest rate environment, MM mutual funds have the opportunity to earn much higher yields than the previously discussed bank savings vehicles. Although very secure in nature, especially government money market funds, they are not FDIC insured. They must be bought and sold like mutual fund investments, which means it does take time for the funds to transact and transfer to a bank account.

Treasury I-bonds are savings bonds issued directly to individuals by the U.S. Government. I Bonds return is generated by two components: a fixed rate attached at issuance and a variable rate that is reset semiannually based on inflation. There is potential to earn very high returns during inflationary periods and low returns during periods of low or falling inflation. Since they are indexed to inflation, money is guaranteed to maintain its real value. There is a $10,000 annual limit per individual, and they must be held for at least one year before the money can be withdrawn. The benefit of potentially high returns during inflationary periods comes with the caveat of a one year required minimum holding period.

As you can see from the five examples discussed, like any investment, there are risk/return trade-offs. The most important part of cash management is making sure preservation of principal is secure and fully liquid money is readily available at the time it is needed. Different cash investments are appropriate for different objectives. For instance, storing an emergency fund and saving for a home down payment needed in one year’s time may necessitate different cash vehicles. It would not be appropriate to purchase I Bonds with emergency fund money because of the required holding period and lack of liquidity if needed before one year.

When economies move through the economic cycle interest rates change. In 2021 and early 2022, savings accounts, money market funds, and t-bills were all yielding virtually identical interest rates (nothing!) while Treasury I-Bonds that are indexed to semi-annual inflation prints were yielding almost 10% at one point! Now, the landscape couldn’t be more different. While bank savings account yields are still low, inflation has peaked and is receding, and money market mutual funds and t-bills have increased to rates not seen in more than a decade. For investors with a one year time horizon there is now a more difficult cost/benefit trade off between I bonds and certain cash investments. Regardless, there is a huge opportunity for investors with money in cash to be rewarded handsomely for their prudent savings. Currently, many bank savings accounts are earning 0.5% or less (I won’t name names, but my bank offers a pathetic .04%!!), while some money market mutual funds are yielding over 4.3%!

Many people often keep excess savings in bank accounts not realizing the potential interest they are missing out on. Technology and economies of scale have made access to low cost money market funds and t-bills available to everyday investors with no required minimum contribution at many financial institutions. As long as the money will be there when you need it, the current interest rate environment is presenting a well deserved opportunity for savers to be rewarded by allocating their savings to appropriate cash and cash equivalents.

While this post is about maximizing the return you receive on your cash, it’s also important to remember that cash is just one portion of an overall investment portfolio. Cash is there to provide liquidity and stability, especially during times of economic distress. However, cash should never be viewed as your primary wealth building asset. If we look back over the last 20 years (2003-2022), the average return on cash measured by 3-month T-bills was 1.22% annually. Stocks on the other hand, measured by the S&P 500 index, returned about 9.5% annually over this period and Real Estate Investment Trusts (REITS) averaged almost 9%.