In this podcast, Motley Fool host Dylan Lewis caught up with Motley Fool personal finance expert Robert Brokamp to discuss:
- How banks benefit from your inertia, and how that costs you.
- Ideas for managing cash for the next few weeks, months, and years.
- Money market funds paying more than 4%, and the caveats to understand before utilizing those accounts.
- Who can benefit from I Bonds and less-liquid savings vehicles.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on May 20, 2023.
Robert Brokamp: Whether or not we have a recession, to me actually isn't important. The economy is slowing down. It's at this time where you actually might want to keep more of your money shorter term-ish, except that there's always the possibility that rates will go the other way and you'll be happy that you locked up some of your money for whatever, 1, 2, 3 years.
Mary Long: I'm Mary Long, and that's Motley Fool Senior Advisor Robert Brokamp. Dylan Lewis caught up with Rob to talk about managing cash when interest rates are high. They discussed the boring piece of financial advice that's essential for any investor to understand, some savings vehicles that can help minimize your taxes, and how the debt ceiling debate is impacting treasury bills.
Dylan Lewis: We often talk about the importance of cash, it is the bedrock for your financial picture, and having it on hand can turn market dips into opportunities rather than painful pinches. Today we're talking about its importance and also how to make the most of it. I'm Dylan Lewis and joining me to do that is the Motley Fool's resident answer of all things personal finance, Robert Brokamp. Robert, thanks for joining me.
Robert Brokamp: My pleasure, Dylan. Great to see you.
Dylan Lewis: Great to have you in studio with me. I think the theme of this show is going to be that the foundational guidelines when it comes to cash and how to manage it probably haven't changed very much and are going to be very familiar to a lot of people. But given the environment, how and where, when it comes to cash, is probably worth considering or reconsidering for a lot of people.
Robert Brokamp: Definitely, this is the time when putting a little effort and thought into what to do with your cash can really pay off.
Dylan Lewis: I think just given where we've been with interest rates over the last, probably two years, a lot of assumptions that people have, and I'm certainly one of those people that have had really hard-baked assumptions are worth challenging, and it's just because what we're seeing is so different than what we've been experiencing. I'm someone who financially came of age right after the great financial crisis. Interest rates have been as low as they possibly could have been. Imagine a lot of our listeners who came at financial aid around the same time feeling the same way.
Robert Brokamp: Same with inflation too. Inflation was so low, so you felt like, OK, I'm not getting much on my cash, but it's not really losing much to inflation. Now it's a different story where we do have high inflation. If you're just sitting there with your money in the bank, you are significantly losing out to inflation.
Dylan Lewis: Nobody wants to be doing that.
Robert Brokamp: No, absolutely not.
Dylan Lewis: We're going to structure the conversation in the way that really should we think about cash? We're going to build from the bottom, make sure that the foundational stuff is taken care of, and then get to some of the fun stuff and talk a little bit about maximizing what people have available. Let's start with what I think everyone knows to be the foundation here, and that's the emergency fund.
Robert Brokamp: The most boring advice in personal finances, except that it's important. The classic advice is, have 3-6 months of must-pay expenses somewhere safe and liquid, savings account, checking accounts, something like that. Even though it is the perennial advice, I would say there is a bit of timeliness to this because if you took a survey of most economists, they do expect the economy to slow down, they do expect that unemployment will go up, we might have a recession, which means the chances that you'll lose your job have gone up a little bit more, and this is what you need an emergency fund for, so that if you lose your job, you can still pay your bills. The more mouths you have to feed, the more obligations you have like mortgages and car payments, the bigger your emergency fund should be.
Dylan Lewis: It's the preventative maintenance that we all know we should be doing and thinking about particularly at a time when we don't need to be thinking about doing it.
Robert Brokamp: Exactly. No one likes it because you don't earn much money on cash, but you can a little bit if you put some effort. But it's like insurance, you're not buying it as an investment, mostly you're buying it to protect yourself.
Dylan Lewis: You talked about how it is the boring advice that we all know or we all start out with. But what's fun about the current environment is it is no longer this drag on your investment returns that I think it has been for a long time because we're starting to see a lot of places where you can get a pretty healthy yield on money that's sitting in a savings account.
Robert Brokamp: Yes. But you have to put in some effort because the local bank and the big banks, they're counting on your inertia to not move your money.
Dylan Lewis: I'm one of those people. I've banked with Bank of America for incredibly long time. They were first bank account. I have to say, I think they've taken advantage of that relationship.
Robert Brokamp: Many of the biggest banks don't need more money. They're not hungry for deposits. They don't have to jack up the rates they're paying because they're like, it's OK, we're happy with the money we have already.
Dylan Lewis: To put some numbers to that, I think a lot of people that are with big banks and maybe haven't taken a hard look at what they're getting on their cash recently, are probably seeing maybe one basis point, four basis points of interest when it comes to their savings accounts. There are a lot of places where you can be getting a lot more than that.
Robert Brokamp: For example, the Motley Fool does have a website called The Ascent, and it highlights higher-yielding checking accounts, high-yield savings accounts, and higher-yielding CDs. Generally, you do have to be comfortable with cyber banking, some sort of online bank. There are some local banks that are also there. But if you're willing to go with an online bank, you can get a savings account that is over 4%, you can get CDs that are almost 5%.
Dylan Lewis: Depending on what measurement you're looking at, that may be something that puts you at least over the historical hurdle for inflation. Maybe not where we've been recently, but considering it is essentially a risk-free return there, it's not too bad.
Robert Brokamp: Exactly.
Dylan Lewis: With the core elements of the emergency fund out of the way, that's that intermediate and near-term money, how should people be thinking about that? It's probably the next couple of years, but it's not in the next couple of months.
Robert Brokamp: First of all, it's a bedrock of Motley Fool investing that any money you need in the next 3-5 years should not be in the stock market. Could be something that you're going to buy a house, buy cars, send your kid to college, or you could be retired. Another bedrock for retirees is that you have what we call an income cushion. You think about how much money am I going to need over the next five years for my portfolio? That should be out of the stock market, and that could be in cash. Now, it doesn't have to be all completely liquid. You could do things where you take a little bit more risk, both in terms of where you put the money and maybe tying it up. For example, we like bank accounts and CDs because they're FDIC insured, which is great, up to a certain limit, and maybe we'll get more into the details on that later. But if you're willing to take a little bit more risk, there's money market funds. They're not FDIC insured, but most of them are paying almost 5% and some of them are paying over 5%. It's a little bit risk because they're not FDIC insured. If you look at the fine print on your money market fund, it could say something like, we can basically put a gate on redemptions during tough economic times. Just be aware of that. Then you can also think in terms of buying individual treasuries. What I like about individual treasuries is the rates are commensurate with CDs. Treasuries are about as safe as anything that's FDIC insured because it's still backed by Uncle Sam, but they're free of state income taxes, and more than 40 states charge an income tax, so it's an extra bonus. These days you could get anywhere between four and 5% depending on the short-term treasury you're looking at.
Dylan Lewis: A lot of what you mentioned there were fairly liquid vehicles or opportunities for folks. I know that as you start getting into things like CDs, you start to look at locking money up a little bit more. You ought to talk a little bit about just the mindset with what exists within some of those more liquid accounts versus what you should be willing to be putting into things that have A6 or a one-year time element to it.
Robert Brokamp: With a CD in particular, if you buy a two-year CD, the good thing is they know exactly what you're going to earn for the next two years, you're locking it, and that's actually a hedge against rates going down, we'll talk about that a little later. But if you redeem it too soon, you'll pay generally a three-month interest penalty. It is something that you have to be comfortable leaving alone, and it's great if you have a certain goal that you know you need a certain time, again, like your kid's going to college in two years, that's a good option for that. Another option if you're willing to lock up your money a little bit are I bonds, and I bonds got a ton of attention over the last year because the yield was crazy high. A year ago, they were yielding 9.6%.
Dylan Lewis: Virtually unheard of.
Robert Brokamp: Yes. Crazy. It's a little bit misleading because that's the annualized yield of what they will pay over the six months. No one actually got 9.6% over the year. It's funky that way, but still very attractive. I Bonds are made up of two rates, really, there's a fixed rate and one rate that changes every six months according to inflation. The current yield on I bonds is at 4.3%, which sounds bad compared to where it was beforehand. But the fixed rate is higher, the fixed rate is 0.9%, that's the highest fixed portion since 2008. So no matter what happens, you know that at least this money will beat inflation by almost 1%. Like treasuries, also free of state income taxes, and you can defer the taxes, so you don't have to pay them every year, so you only pay when you redeem the bonds. They are not exactly liquid though, because if you buy an I bond, you have to leave it alone for one year, and if you redeem it within five years, you pay a penalty of three months worth of interest. But it's great for, let's say you are within five years of retirement. You start building up your income cushion, that cash you need to spend when you retire by buying I bonds. Very safe because it come from Uncle Sam. Don't pay state income taxes, you don't have to pay the taxes each year because you can defer the taxes. You retire, you begin to redeem them, that's when you pay the taxes, but most people had a lower tax rate when they retire. You're basically doing some tax arbitrage because you have deferred at a time when you are in a higher tax rate and paying taxes at a time when you're in a lower tax rate.
Dylan Lewis: You mentioned that a lot of people became suddenly interested in I bonds. I think a lot of people have probably very suddenly become interested in FDIC insurance as well, given the current state of our banking system and given what we've seen with some pretty big name banks over the last couple of months. I'm curious, we think about diversification in investing in terms of owning a lot of businesses and not having a whole lot of eggs in one basket. What elements of diversification should people be thinking about in addition to where the money is held in terms of vehicles, where money is held in terms of firms?
Robert Brokamp: The FDIC insurance, as most people know, it's up to $250,000, and that's on generally checking accounts, savings accounts, CDs, and money market accounts. Not money market funds, money market funds are different there, don't have FDIC insurance, money market accounts do. The thing is, it's $250,000 per type of account. You could have 250,000 on your own account, your spouse could have 250,000 in his or her account. You can have a joint account with another 250,000 and then you could have IRAs at the same bank, and as long as it's FDIC insured investments, that's another 250,000. You could get a lot of coverage within one bank. FDIC actually has a great tool called the ED tool, electronic deposit insurance estimator, if you want to see how much of your FDIC deposits are insured.
Robert Brokamp: But you can get a lot as long as you arrange things correctly. But it's still important to think of diversifying your cash among banks. You don't want all your money with one bank, especially if it's a bank that might be struggling and recently we are paying much more attention to that type of stuff. The FDIC does a great job of taking over banks and make sure things they keep running smoothly, but still you don't want that stress in your life. Then the other part of the diversification I would say is that doing again what we talked about previously, you want to diversify like, what do I need to have absolutely liquid something that I could spend immediately versus money that I'm willing to tie up for a little bit longer in the hopes of getting a little bit higher interest rate.
Dylan Lewis: The idea there is, we're not tying all of this money up on the same timeline. For folks that are generally thinking about things like bonds, there's a principal called laddering. Is it appropriate to think about it the same way?
Robert Brokamp: Exactly. It's a little trickier nowadays because in normal times, you go further out with a bond or a treasury or a CD, you earn a little bit more interest. Nowadays that's not quite the same. The sweet-spot nowadays is about one year, maybe two years. But still you could buy six months, one year, two year to get hopefully a little bit higher interest rate. But it does mean that you have to lock up your money a little bit.
Dylan Lewis: That sounds like another traditional mindset thing that people need to challenge when it comes to locking up their money and the interest rates they are going to be getting,.
Robert Brokamp: These are interesting times. You've probably all heard that the yield curve is inverted. You get more money nowadays from a six-month treasury than you do from a two-month treasury than you do from a 10-year treasury. That is a classic sign of the economy is slowing down and historically a sign that we're going to have recession at some point in the future. Whether or not we have a recession, to me actually it isn't important. The economy is slowing down, so it's at this time where you actually might want to keep more of your money. Shorter term-ish, except that there's always the possibility that rates will go the other way and you'll be happy that you locked up some of your money for whatever 1, 2, 3 years.
Dylan Lewis: I want to talk a little bit about the macro picture because in addition to all of the other things that people have had heightened interest in recently, a lot more people are paying attention to the Fed than they have been over the last five years, 10 years. It's become something that conversationally pops up a lot more when you're out with friends. How are you thinking about the macro picture and just generally, what we've seen with interest rates from the Federal Reserve?
Robert Brokamp: The Federal Reserve raised rates again at their May meeting, but clearly indicated that that could have been it for this cycle though, who knows? Maybe there'll be a surprise spike in inflation. They recently had that in Europe. But most people expect inflation to keep coming down, which means that Fed is probably done hiking rates. In fact, if you look at the Fed futures market that tries to guess these things, they are betting that the Fed is going to cut rates before the year is over. Now the Fed has been pushing against that narrative. Various Fed officials have been out saying, do not expect that we're going to cut rates. But to me, it seems pretty obvious that they're not going to hike rates that much anymore which gets back to that point of, maybe you do want to use with some of your safe money, buy some individual treasuries, individual CDs to lock in current rates because it's very possible that rates will be lower a year or so from now.
Dylan Lewis: It's something that I think a lot of people have to wrap their head around. We've been talking about the unprecedented times element of all the things that we're living with seemingly for the last three years and we keep seeming to throw things on top of it. More things that are being challenged or being adjusted. There's so many different ways that interest rates wind up coming in and affecting the economy. I think what a lot of people are beginning to appreciate much more as the way that it comes in and affects the pocketbook.
Robert Brokamp: To add to all of that, of course, is this whole I don't even call it a debate, whatever about the debt ceiling. That has played havoc with the short-term treasure bill market 1, 2, 3 months because people are like, I don't want to buy Treasury bill which is basically lending Uncle Sam money because I don't know if two or three months from now, they're going to have this worked out and I'm going to get my money back. Longer-term, the bond market is saying, Uncle Sam's going to figure this out. But short-term, it's been wacky. I think it's all going to work out, but I'm sure people when they hear me say buy T-bills, the first thing that I thought as well, who knows what's going to happen about this? That's the only thing. You've got Janet yelling on the news every day saying, if we don't work this out, it's going to be a calamity.
Dylan Lewis: To what extent do you take that stuff into account when you're thinking about cash management. Just the way that you would advise people to put their money to work. Is it something that's really weighing heavily on the way that you do that or is it something that you have to accept that there's only so much we can know about that?
Robert Brokamp: Again, it goes back to the diversification. Any money in the bank is going to be fine. If you have a diversified bond fund, maybe you'll be fine. I personally think they're going to work it out because the consequences of Congress and the President not working out will be so bad that they're not willing to do that. They're going to keep doing this Kabuki dance where they say, I want this to happen. Well, I'm not going to budge and then they budge and it gets worked out. Longer-term, we can't keep doing this. I hope they figure out some way around this because otherwise, we're just going to have to keep doing this every year, every two years, every three years.
Dylan Lewis: We've talked about interest rates in the macro picture. We've talked about the debt ceiling. Are there any other macro factors you see playing into the way that people should be thinking about this stuff?
Robert Brokamp: I'll just repeat something that is really my mantra at all times and that is be a short-term pessimist and a long-term optimist. You don't know what's going to happen over the short term. We don't know if we're going to have recession. You don't even know if you're going to have a job two or three years from now so you really should save with the money you need in the short-term that you know you're going to need or you might need, but then invest for the long term because overall, we at the Motley Fool believed that the stock market is the place to be.
Dylan Lewis: It seems at least for the foreseeable future, you can enjoy some gains on that money that you have short-term which is nice and something that I think a lot of people aren't particularly used to. I'm going to put you on the spot a little bit here with a question as we're wrapping up. If someone's listening to this and they want some next steps and takeaways for applying some of the things that we've talked about to their own financial picture. To me, it seems like check-in on your accounts and just get a better sense of what you're getting in terms of interest rates from the institutions. If you see that you're someone who's getting some of those lower savings rates, what would you recommend people do?
Robert Brokamp: I hate to be too promoting of a Motley Fool site, but the Ascent is a great place to look for higher-yielding savings accounts and CDs. If in your brokerage account, see what money market funds are available. Isn't that the thing that brokerages do, they keep money in cash that just sits there. Might be in a sweep account, might be just regular cash, but you're probably earning virtually nothing on that so you think about how much really liquid cash do I need. Then look for higher-yielding opportunities. The most important thing I really think is to evaluate how much cash you need, look out over the next 3-5 years and think, how much am I going to need? Is there any big expense coming? Then rearrange your portfolio so you are protecting the money that you think you may or you definitely know you're going to need in the next few years.
Dylan Lewis: All of the compoundings happens with the money that's in the market because it's not being touched, it's being left alone.
Robert Brokamp: Exactly.
Dylan Lewis: Well, Robert Brokamp, thank you so much for talking to us.
Robert Brokamp: Great. It's been a pleasure to be here.
Mary Long: As always, people on the program may have an interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.
