In a diversified portfolio, it is important to have cash. These readily available funds can help you cover expenses without selling investments and give you the opportunity to make a new investment at a moment’s notice. Additionally, interest earned on cash can add to your portfolio return – especially in times like today where interest rates are elevated.
If you want to preserve the accessibility of your cash while also earning a return, you have two main investment options – a bank account or a money market fund. These accounts are similar in some ways, but there are important distinctions between them. You can decide which is more appropriate for your situation by understanding the advantages and disadvantages of each.
Option 1: Keep Cash in a Bank Account
Bank accounts come in several varieties that have their own important differences. The three most popular types of regular deposit accounts are checking, savings and money market accounts. All of these accounts offer comparable benefits and drawbacks, but there are some important differences you should know.
Benefits of Keeping Cash in Bank Accounts
One of the main benefits of a bank account is safety, and that comes in the form of Federal Deposit Insurance Corporation [FDIC] insurance. This government insurance keeps at least $250,000 of your funds safe at each insured bank – so you can relax knowing that your cash in a checking, savings, or money market account will be there when you need it.
In addition to safety, accessibility is another benefit of bank accounts – meaning that it is easy to access your cash when you need it. Bank accounts typically offer many ways to reach your money including checks, debit cards, online transfers, automatic bill payments, and ATMs. The variety of ways to access your money makes it simple to pay your bills and reach your money when you need it.
Drawbacks to Keeping Cash in Bank Accounts
While bank accounts provide many benefits, they also have drawbacks. One of the most common downsides is lower yields compared to other cash equivalent investments.
In fact, the average checking account yielded just 0.07% as of October 16th while savings and money market accounts paid 0.46% and 0.65%, respectively. These lower yields mean that the interest earned on cash in a bank account is often not enough to outweigh inflation much less meaningfully add to your portfolio return.
With easy access to cash, and peace of mind knowing your funds are protected by the FDIC, bank accounts can be an excellent place to keep cash that you plan to spend in the short term. On the other hand, lower yields can make these accounts less appropriate for those seeking to earn money on their cash.
Option 2: Invest Cash in a Money Market Mutual Fund
Though similarly named, money market mutual funds are different than money market accounts offered by banks, so be careful not to confuse them. Money market mutual funds differ because they are not simply an account to store your cash. They are collections of short-term, high-quality debt instruments packaged and sold as a single investment.
Like other mutual funds, money market funds pass income from the underlying investments to you – the shareholder – typically in the form of monthly dividends.
Money market funds are unique because they seek to maintain a steady, $1 per share value – similar to the stable value of a dollar in a bank account. Since the per share value of a money market fund doesn’t usually change with the economy or investment markets, they are often called ‘cash equivalents.’ However, be careful to understand that these funds are not cash, so they have important benefits and drawbacks you should know before investing.
Benefits of Money Market Funds
One of the main benefits of money market funds is that they typically pay much higher interest rates than bank accounts. In fact, the average yield for a prime money market fund was 5.43% in July. This rate is more than 8 times higher than the average money market account from a bank and more than 75 times higher than the average checking account. These higher yields help protect the value of your cash against inflation and add to your portfolio return.
Along with higher rates of return, money market funds have similar safety to bank accounts. This safety is provided by the Securities Investor Protection Corporation [SIPC] – a membership corporation that provides insurance for securities. SIPC protects up to $500,000 in securities – including money market funds – and $250,000 in cash per account owner at each member financial institution. This insurance can give you peace of mind knowing that the cash you invest in a money market fund is safe.
Drawbacks of Money Market Funds
While there are many benefits to money market funds, they do have drawbacks as well. Namely, they tend to have slightly less accessibility than bank accounts.
While bank accounts often make it easy to access your cash through checks or debit cards, brokerage accounts – which hold money market funds – rarely include these features. Instead, you would need to sell your shares of the money market fund then transfer the proceeds to your bank account to spend after that transaction has cleared. The transfer process can take between a few days and a week, depending on the method you use. This delay makes it slightly more difficult to spend the money in a money market fund than a bank account.
For those who favor returns over accessibility, money market funds can be an excellent choice. These investments don’t typically replace your checking account for everyday purchases, but act as a secondary investment to capture higher returns on cash not needed immediately.
How do you decide where to keep your cash?
When deciding where to keep your cash, you will need to balance accessibility with returns. It usually makes sense to leave some money in a checking account to cover bills and everyday spending. You may also have other cash – such as your emergency fund – that could benefit from a higher yielding money market fund.
An experienced financial advisor can help you determine how much of your portfolio to keep in cash. Then, they can help you choose the cash equivalent investments that match your unique situation. This often involves investing cash to achieve your preferred balance between accessibility and returns.
Discuss Your Investments with Meld Financial
At Meld Financial, our experienced team has spent nearly four decades helping clients manage their investments and reach their financial goals. We do this through our comprehensive wealth management program – Financial Fingerprint™. This program is quick to assemble, easy to understand, and simple to modify as your circumstances change.
With Financial Fingerprint™, you can understand how much cash you need to keep on hand. Then, our experienced advisors can help you decide where to invest that cash.
If you have questions about your portfolio or goals, reach out to our team today. We can help you analyze your investments and decide how to allocate your money so that it works for you.
