The Federal Reserve just announced its latest rate decision, holding short-term interest rates steady at 3.75% to 4.00%.
And with inflation still running higher than the Fed would like, two Fed officials actually voted to raise rates further.
That’s potentially good news if you have money sitting in cash.
But there’s a catch. Your bank doesn’t have to pay you more just because interest rates are higher.
I’ve seen people spend hours reviewing their investment portfolios while paying almost no attention to the cash sitting in their bank accounts.
In fact, most people couldn’t tell you what interest rate their bank is paying them.
Consider a family with $500,000 sitting in a bank account earning just 0.01% annually. That’s barely $50 in interest over an entire year.
At a hypothetical 4% yield, that same balance would generate $20,000 annually. That’s an additional $19,950 a year.
What could you buy with an extra $20,000?
Your Bank Is Earning Interest on Your Money
Banks use customer deposits to help fund loans and other investments. They earn interest on those assets, pay depositors a portion of that income, and keep the difference.
Your cash is already working for someone. The question is how much of the benefit you’re receiving.
It’s a business model that’s worked for generations.
But even when banks are earning more interest on your deposits, they don’t necessarily share those higher earnings with you.
Some banks offer competitive interest rates to attract deposits. Others continue paying next to nothing, even when better-paying alternatives are readily available.
You can see just how little some banks pay by looking at Bankrate’s Interest Checking Account Index.
And having a substantial balance doesn’t guarantee you’re getting a better deal.
Someone with $500,000 in a traditional checking account may earn the same negligible interest rate as someone with $5,000.
Put Your Cash Where It Makes Sense
One reason cash sits around earning next to nothing is that people haven’t decided what to do with it. Another is that they simply didn’t realized better options exist.
Maybe you’re waiting to buy an investment property, anticipating a large tax payment, or simply keeping money available for an opportunity that hasn’t yet presented itself yet.
A useful first step is to divide your cash into three buckets based on what you’ll need it.
Bucket 1: Money You Need Now
This is the money for everyday expenses, upcoming bills, and unexpected needs.
Keep it readily accessible. You don’t need to chase the highest interset rates on every dollar in this bucket.
Bucket 2: Money You’ll Need Within the Next Year or Two
This mnight include funds for a home or investmetn property purcahse, a significant tax payment, or a planned business investment.
You know you’ll need the money, but you probably won’t need it tomorrow.
This is where earning a competitive yield can make a difference.
High-yield savings accounts, money market funds, and short-term Treasuries are worth considering, depending on how quickly you might need access to the funds.
Bucket 3: Money You Don’t Expect to Need for Several Years
This is where I'd encourage you to ask a different question: Why is this money sitting in cash?
You may have a good reason. Perhaps you’re waiting for an opportunity or simply prefer maintaining additional liquidity.
But not letting go of the cash security blanket can be expensive.
If you don't have a clear purpose for those funds, it may be worth considering whether they belong elsewhere in your investment portfolio.
As I discussed in The Price of Money Has Changed, interest rates have changed the opportunities available to investors.
Don’t Let Perfect Get In The Way Of Better
Once you've identified your cash buckets, the next step is actually moving the money.
This is where people often get stuck.
They spend time comparing interest rates, wondering whether the Fed will cut rates next month, or waiting to find the perfect place for their money.
Meanwhile, their cash continues earning next to nothing.
You don't need to predict the Fed's next move to improve what you're earning on your cash today.
Consider starting with the money in your second bucket.
Determine how much you’ll need over the next year or two, compare a few appropriate options, and move that money into an account or investment that offers a competitive yield while meeting your liquidity needs.
You can always revisit the decision as your circumstances change.
A Cash Check-Up That Pays
Take a few minutes to add up your cash balances. Add up your cash balances and identify what you’re currently earning.
Keep what you need readily available, earn a competitive yield on money earmarked for future expenses, and reconsider cash you don't expect to need for several years.
You may discover that everything is already arranged appropriately.
Or you may find that a relatively simple change could generate thousands of dollars in additional annual interest.
Your money should be working for you, even when it’s sitting in cash.