If you're an investor, you have a close relationship with your money. You do a lot of legwork trying to figure out the best ways to earn the greatest return on your investments, whether it's poring over reams of company and fund literature, checking out the Fool, or seeing what other investors are saying at the Motley Fool CAPS stock-rating community. And since you work hard for your investments, it's only fair to expect your money to work hard for you. Given enough time, the combination of good performance, compound interest, and regular savings will leave you a winner -- as long as your money's doing what it's supposed to do.
Cash management
Like a lazy office worker lingering around the coffee pot all morning, your money might not be doing everything it can to earn income for you. But usually, you can do something about that, as long as you don't overlook some obvious things.
For instance, many banks offer "free checking" accounts that help you avoid monthly maintenance charges and other common bank fees. That's good if you can make it work, but there are some drawbacks. First of all, some of these accounts require that you maintain a certain minimum balance at all times -- sometimes as much as $2,500. However, if you drop even a dollar below the minimum, then you'll find those monthly fees on your statement the following month. Even worse, many of these accounts pay little or no interest on your money.
With some checking accounts now offering as much as 5% interest or more, it's a much bigger deal where you keep your short-term savings than it was just a few years ago, when interest rates were extremely low -- even on money-market mutual funds and other high-interest cash accounts. So if you have to keep a minimum balance of $2,500 in an account that doesn't pay any interest, you're giving up $125 each year that you could have earned. Furthermore, since you're probably careful never to go below the $2,500 minimum, you probably keep significantly more than the minimum in your account. If you park $10,000 in a no-interest checking account -- an amount that's not uncommon -- you're sacrificing $500 or more in interest every year. If that sounds like you, it makes a lot more sense to find a checking account that will pay you higher interest than to focus solely on avoiding relatively small bank fees.
CD inertia
Many people avoid the low-interest checking-account trap by investing some of their money in certificates of deposit. However, if you're not careful, you can lock yourself into some unattractive investments. Bad timing can leave you with a CD whose rate may look much worse just a few months after you open your account. Yet most people end up sticking with a bad CD until the bitter end.
For example, low interest rates over the past few years had many people buying long-term CDs at low rates. If you bought a five-year CD in 2003 or 2004, you might have gotten as little as 3% on your money, and with current five-year CD rates as high as 5.4%, you may lose as much as $2,400 each year in interest over the remaining two or three years on a $100,000 CD that you had the bad luck to open in '03 or '04.
Depending on the terms of your current CD, it may actually make sense to cancel that low-interest CD now and replace it with a new CD at a higher rate. Even if you pay an early withdrawal penalty equal to three months of interest, that's only $750 on a $100,000 CD paying 3%. With the higher rates available now, you'd make that interest back in fewer than six months. Don't let a perceived stigma against cashing in a CD early keep you from making a smart economic decision.
The lesson
Cash accounts and certificates of deposit aren't necessarily as glamorous as stocks, and they're unlikely to provide you with the stellar returns that every investor dreams of finding. However, making sure that your money is working as hard as it can for you can add hundreds or even thousands of dollars in savings to your portfolio every year. As hard as you work to make money, shouldn't your money work as hard for you?
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Fool contributor Dan Caplinger uses Treasury bills to manage cash, even though it means extra work every week.
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