In the past cash management was a big part of financial planning. The goal was to allocate cash holdings, whether it be money set aside for future expenses, an emergency fund, money to which a goal has not yet been assigned, to an account that would pay an attractive yield without incurring high transaction fees, lockup periods that are incompatible with the goals and objectives, or an unacceptable fluctuation in value. In recent years this has been less of an issue as interest rates have been so low that the benefit from cash management was often quite low. Therefore, many people used zero interest checking accounts or low interest savings accounts for convenience as the interest differential between these accounts and other higher-yielding options was quite low.
Now that interest rates have increased there is once again a greater emphasis being put on cash management. For the first time since 2006 the FDIC reported that the amount of money held in non-interest paying bank accounts has declined as savers are again shifting their money to more attractive, higher-yielding alternatives. However, while non-interest paying accounts at US banks have decreased by more than $30 billion in the past year, those deposits still represent 26.3% of bank deposits, of $3.2 trillion, showing that many savers have yet to reintroduce cash management into their financial plans.
For example, there is now a greater incentive to shift cash reserves into money market accounts rather than checking or savings accounts. According to BankRate.com many online savings bank are now paying between 1.85% and 2.15% on money market accounts whereas many brick and mortar banks are paying between zero interest and 0.30% on checking and savings accounts. Money market accounts do come with some restrictions, such as limit of six withdrawals per year, but the interest rate differential is now great enough to compensate for the extra planning that may be required to shift money from a money market to checking account so that it is available to be spent when needed.
In addition, Certificates of Deposit (CDs) may once again an attractive option for savers that do not anticipate needing access to their savings for some time. In the past the difference between short-term rates and longer-term rates was very small so that there was little incentive to adhere to the lockup periods required by CDs. Now a one-year CD may yield 2.65%, a two-year CD may yield 3.05%, and a three-year CD may yield 3.15%. This larger margin of interest over what a money market may yield can once again make CDs an attractive option for risk-adverse investors or for those who want a low-risk option to fund expenses that are anticipated to occur a few years down the road.
Finally, it may be a good time to reassess the cost / benefit of “free” banking services. Many banks offer customers a no fee checking account as long as they maintain a minimum balance of $25,000 in a non-interest or low interest account. In the past this was an attractive tradeoff as the money could earn little elsewhere so the cost in the form of foregone interest was quite low. Now that the deposit may be able to earn 2-3% the real cost of a minimum deposit in a low cost account may be as much as $500-$750 per year in lost interest. In this environment a “free” checking account that comes with such restrictions may not look as attractive as an offer for truly no fee checking or an account that requires a lower minimum deposit.