One Word That Cost Investors $2B (1-3)

Marcus Schafer (00:17)

This is episode 29 of Return on Reason where logic meets life and investing is Pat Collins and me, Marcus Schaeffer at Greenspring at Pfizer’s. Cash is such a drag. That’s what we want to talk about today, Pat. What is the role of cash in a portfolio? What are the benefits of cash? But also as I kind of alluded to, what are kind of some of the drawbacks of cash? And maybe to start it off, I’ll ask this question to myself, which is.

What is the difference between $2 billion of investor money? Turns out it is one word, performance. So in 2022, the Fed started raising interest rates and Capital One actually had these two different bank products. They had a performance 360 savings account product and a savings 360 account product. One word was the difference. One raised rates, the other did not raise rates.

 

So investors or kind of normal consumers that were in one product, they missed out on a bunch of essentially free money through higher interest payments. There was a lawsuit as a result of this because the way they did it was a little bit misleading in terms of if you go on the website, you would only see the higher rate. You would never see the lower rates. Even if you were in one product, you maybe thought you were in a different product. They got sued. It was claimed $2 billion.

 

dollars was the cost to investors ended up being about $450 million, $425 million was what was settled. But I say that story to mean, hey, as investors, if we are going to have cash, it is important to think about how to minimize cash. We’ll talk about why, and then what type of vehicle we want to invest that cash in since we’ve already made the decision to have cash to maximize returns.

 

And essentially some of the best, the highest expected risk adjusted returns you can have is on the short end of the curve, $2 billion, one work performance.

 

Pat Collins (02:18)

It’s a topic that everybody is going to need to deal with. I know every single person that’s listening to this, every single person that lives in the United States at least ⁓ has to be dealing with cash in some form or fashion. I think we’re going to, while the topic may seem a little bit boring, it’s very relevant. It can add a lot of value or it can detract a lot of value if you get it wrong. So I think we’re going to get into topics like how much cash should you hold? What are some ways to think about that? How’s it?

 

get incorporated into a portfolio? What if you’re accumulating? What if you’re decumulating? ⁓ And then, you know, maybe even a little bit more detailed and nuances. What are the types of ways you can invest in cash ⁓ or hold cash? You know, obviously there’s banks, but there’s other available options as well for cash. So we’re going to talk through all of that. think it will be relevant to everyone. And hopefully it’s going to be valuable because, like you said, it’s sometimes small dollar amounts.

 

that we’re talking about, it adds up to a lot over time, whether you get this right or wrong. So I think it’s going to be really important ⁓ for investors that are listening to this, hopefully to get some ideas on how they can better manage their cash.

 

Marcus Schafer (03:26)

Yeah. It kind of leads to this first question, Pat, which is, is cash an asset class? How do we think about the definition of cash, the role of cash in somebody’s portfolio that maybe also includes a house, cetera?

 

Pat Collins (03:41)

probably technically, yes, you would consider it an asset class because it’s something you have money in. But I’ll at least mention how we think about it at Greenspring for our clients. And I’m not saying that we’re right or wrong, but I think this is, you we’ve thought pretty deeply about this topic. So we do not consider it an asset class in portfolios. We don’t say we want to own 5 % in cash or 2 % in cash. People that tend to do that, I’ve found, tend to be more…

 

active managers that are trying to place bets on what’s going to happen in the future. So they might say, well, we’re to hold a lot of cash right now because we think things are going to get really bad in the market or we’re going to get fully invested right now. We’re going to take our cash very low down because we think things are going to be great in the market. If you’ve been listening to this podcast long enough, you know, we’re not we’re not predictors of the market. We’re not trying to figure out what’s going to happen. We want to come up with an asset allocation for each of our clients that makes sense and stick with it. With that being said, typically where we start is

 

What is the cash needs out of this portfolio? So for someone who’s not taking money out of their portfolio, it’s very minimal. They might just have a very small percent, you know, less than a percent may be in cash to cover things like advisory fees. ⁓ But other than that, it’s fully invested. And that’s how we think about it is strip out your cash, everything else let’s put into the portfolio that is designed for you. Other investors maybe who are taking money out of their portfolio could be retirees.

 

those that have regular withdrawals out of their portfolio, we will typically set a number of months of those expenses of those withdrawals, we’ll put them in cash and then again, everything else we’re going to go reinvest. So we’re not thinking about it as an asset class, we’re thinking about it more as this is something, this is an upcoming expense that you’re going to have. Let’s just make sure we have enough money set aside to cover that short-term expense that we see happening in the next few months or so.

 

Why Investors Leave Cash Uninvested (4-5)

Marcus Schafer (05:36)

Yeah, it’s a very helpful framework. You know, you have your portfolio and being fully invested in the portfolio is super important. We’re going to talk a little bit around why that’s important from an expected return, some of the headwinds that face cash for investors. Vanguard did some studies on IRAs that are created and essentially the money stays in cash. And an IRA

 

should be a retirement account, so it should be invested in something that’s going to grow over time to fund your lifestyle. And Vanguard’s question is, why are so many investors sitting in cash? So they did this survey, they looked at people that rolled over and created new IRAs, stayed in cash. And here were some of the responses. Almost 70 % of people said that they didn’t even know how their assets were invested. Some, about half the people, they thought the IRA would automatically be invested.

 

I think that’s it. It’s actually a weird thing because in 401ks, there’s a lot of rules that help to make sure people automatically get invested. A third of people just prefer cash. I think that’s important for talking about some of the headwinds. A quarter of people thought there were too many options, so it was hard to make a decision. And then 15 % of people just never got around to investing the cash. And I think that’s…

 

really important because Vanguard also did a different study and they looked at rollovers in 2015, 3, 2022, and they looked at different age bands of people and said, what’s the likelihood this cash ends up getting invested? And essentially across all these age brands, even very young 20 to 29 year old investors, what they first decided on is what they say invest with. There was very little change.

 

over time through that seven year time period. So Pat, maybe let’s talk about why cash should be invested.

 

The Three Drags on Cash (6)

Pat Collins (07:34)

Yeah, it’s this joke we have internally that people spend more time on their fantasy football lineups than they do on their investments. And, you know, it’s just a great study to show that I think that there is a, you know, there’s basically two themes that I hear with that study. One is fear. That’s probably the less of the issue, which is I prefer cash. I don’t know. There’s too many options. I don’t know what to do. I people are afraid to make a bad decision a lot of times with that. But the bigger one that you just

 

to hear through all those responses is neglect, which is I’m not spending a whole lot of time on this. so therefore, I didn’t even know that this money was not invested. The other thing we see sometimes is people do invest the cash, but after years, they don’t realize that maybe it’s been paying out dividends for a while, paid out some capital gains distributions, the mutual funds that in. And all of a sudden, if thousands and thousands of dollars sitting in cash that they didn’t realize had built up because they just had neglect on the portfolio.

 

So why is it important to invest your cash? I think is, is probably, you know, obviously the question there. And I think it’s a fairly simple question, which is we want to earn returns in excess of inflation so that we can live a lifestyle in the future. It’s the whole point of investing is we want to grow our assets so that we can enjoy it in the future. ⁓ I did some research or just actually not even research, just some calculations to give you an idea on why we want to invest cash.

 

Over a 20 year period, if you have 3 % inflation, which is about the long term average for inflation, you lose about 45 % of your purchasing power if you don’t earn anything on your money. if you have your money sitting in cash and some sort of near 0 % kind of vehicle, like a checking account or something like that, your $100 of cash today will only be able to buy $55 worth of goods in the future.

 

So that’s why we need our cash to be earning something more than zero and preferably something more than inflation. At a minimum, we want to earn inflation just so we can keep up with purchasing power. But hopefully we can earn a little bit more than that so that we can buy more things in the future.

 

Marcus Schafer (09:47)

In finance speak, what you just described is the real return, right? So this is a, what is my return over and above inflation? And inflation is something that’s just kind of hidden. That is one headwind. There’s a secondary headwind for taxable investors, which is taxes, right? And even if you are in a higher yielding cash type strategy, a lot of the type of income

 

that interest kicks off is going to be fully taxable to you. So that’s going to be fully federally taxable, fully state taxable. And the combination of those two headwinds, essentially it flips your mindset on cash from cash isn’t risky, which is true in the short term, to cash is risky, which is true in the long term. And when you look at the number

 

When you look at different stats that compare risk, right? What you’ll see is if you have your cash fully invested in stocks or a mixture of stocks and bonds, the likelihood you lose money over one year, it goes up in that fully invested case compared to staying low for cash to essentially there’s close to a 0 % chance you’re going to lose money over the course of a year. But then your point when you stretch that time period of five or 10 years,

 

It flips dramatically. And I was looking at some numbers that essentially like post 2010, it’s like 75 % of the years, if you were just in cash that time period, that’s a negative outcome for you. lost, you lost money.

 

Pat Collins (11:29)

The interesting thing about that, we’ve always told clients that there’s really two types of risk and this is what you’re getting at. There’s the short-term volatility, which is the risk that everybody understands, which is I could put my money in the market today and the stock market and I could lose 10 % or 20 % or 50 % over the course of a year. That’s real risk to me because I see this volatility happening. The other risk is inflation or losing purchasing power over time. That’s a risk that is harder for people to understand because it’s harder to see that.

 

It happens very slowly over time in most cases. So 3 % loss to your purchasing power every year. It’s very difficult to see that, especially on a daily or weekly basis compared to the market where you can lose 5 % in one day in the market. And so that’s the kind of the rub here is what’s the way that you counteract this short-term volatility? Will you invest in things like cash? Because

 

I don’t have any ups and downs. It stays flat every single day. don’t have to worry about it. But most people don’t think about that long-term risk, which is that loss of purchasing power that is going to happen. It’s just going to erode. So this is an important distinction when you’re thinking about how much cash should I hold, just realize that the more cash that you hold, the more challenges you’re going to have with inflation and ⁓ losing purchasing power over time.

 

Marcus Schafer (12:53)

The other thing I think you’re alluding to, Pat, is there is this disconnect between the numbers you see and maybe the numbers that are actually happening. Another thing I think is tax, right? So if your tax bill is going up, you might not be associating, hey, your tax bill is not going up. You’re probably thinking it’s because of my job. That’s why I’m paying more taxes. It could be because of also the type of income you’re receiving.

 

And that’s driving up your taxes. I think there’s also this question of, well, you know, it’s, it’s a thousand dollars or it’s $5,000. How meaningful is that? And one of the things we think about is it really becomes meaningful at different stages of your life. And that can be really meaningful because if it jumps you up in a big tax bracket or reduces your odds of being able to do a Roth conversion or something at a specific time, that is detrimental.

 

Maybe let’s just think about, well, there’s all these headwinds. What are the different types of accounts that you can incrementally step up your yields across? So maybe just walk through what are some of those step-ups in yield investors can go and get?

 

The Cash Yield Ladder

Pat Collins (14:09)

When people think of cash, think the immediate thought is obviously, you know, dollar bills. So obviously we would never really advocate that, but that’s probably where you would first start is accumulating actual hard, hard assets or hard dollar bills. But really for most investors, you know, you kind of move to the banks, which is checking accounts is kind of as people start with a checking account, that’s usually the most operational kind of account that you need for cash. ⁓ Then you have savings accounts.

 

⁓ Again, typically at a bank, usually they’re going to offer a little bit more interest on a savings account versus a checking account. There might be a little bit more operational restrictions on those, meaning that you can’t be writing checks out of those or making transfer out of those day after day after day. ⁓ You know, as you move up, then you have things like money market accounts, which tend to be more investment. They’re taking your cash and it’s probably a good distinction now to talk about what banks do with your cash. Banks basically

 

take in your cash, they pay you ⁓ some level of yield, that’s the interest rate that you’re earning on it. And then what they’re doing with your cash is they’re lending it out to people that are looking for a loan. That’s kind of the purpose of a bank. And the way the bank makes money is to spread between the two of that. So if I pay you 1 % and I loan your money out at 6%, I get to earn 5%. That’s called the net interest income. That’s how the bank makes money. So that’s fairly typical.

 

Where you get into when it goes to money markets where it’s a little bit different is typically, you know, at least the money market mutual funds, basically how they work is they’re taking your cash and instead of loaning it out, they’re actually buying short-term securities, you know, basically loans that are made maybe overnight or over a few day period, something like that. So higher yield, very short turnover, but they typically have higher yields than checking or savings accounts.

 

And then you can move into things like maybe a little bit less liquid, but things like CDs, certificates of deposit. They may have a little bit longer period that you have to hold them. Everybody’s probably familiar with these. They’re offered by banks, but you know, there could be a one month CD, three months, six months, 12 months. You you typically would see the longer you go out a little bit higher yields, not always, but typical. And then you can move into things like treasury bills, which are similar to certificates of deposit. They are just issued by the U S government. So.

 

There are other vehicles as well, but as you kind of keep stepping up there, you know, kind of brought it along the yield spectrum. Although, I mean, I’m interested in your take. I don’t know if we see much of a risk differential between any of those things, but there is a difference in yield for sure.

 

Marcus Schafer (16:55)

So those are the different products. I think one of the things that is like liquidity is a change as you step up, right? There’s different considerations of how easy it is to access your money. think those differences in the way that the financial intermediaries have evolved are becoming a lot less than what they were five, 10, 15 years ago. Like it is not that much of a difference to incrementally step up.

 

So you have liquidity differences. How easy is it to access your money? I think that’s narrowing. Another kind of change you have is this difference in risk, which is what you allude to. There’s probably what’s the risk of the item you purchased being worth the same amount ⁓ in terms of the dollar price. But then there’s also kind of this insurance risk. think insurance risk.

 

is something we should dive into here in a little bit. And then yield, the stated yield, that’s a difference. But probably the thing that you and I are focused more on is what’s the tax equivalent yield? If you are thinking about this in a taxable investor, and as you incrementally step up, that’s one of the mechanisms that you can really flip is think about, can we first get a higher yield?

 

But second, is there opportunities to maybe get a stated lower yield, but there’s a tax advantage that actually makes it a higher yield to you as an investor. So before we kind of talk about some of the tax stuff, maybe just walk through some of this insurance considerations, because I do think that is super, super important.

 

How Deposit Insurance Works (7-8)

Pat Collins (18:40)

Yeah, this is a lot to unpack here, but we’ll kind of get into the, yeah, this called the FDIC, Federal Deposit Insurance Corporation. Basically, it’s a agency that essentially insures your deposits at the banks. This came after the Great Depression and there were so many people, there’s so many runs on banks, meaning that all of these people said, I need to take my money out of this bank. This bank is failing. They made bad loans. The loans are going to fail.

 

They won’t have the money to pay me back. So I need to get my cash out. When you lose that confidence in a bank and there’s what’s called a run on a bank, it typically is the beginning of an end a lot of times for a bank. So ⁓ this FDIC insurance was developed so that people knew that there was a backstop, that I didn’t have to worry about my bank failing, even if it failed, even if it went under, the federal government’s going to step in through this insurance program and pay me back.

 

And so that hopefully was going to prevent runs on banks. And largely it did over the next 100 years or so since the Great Depression. With that being said, there are limits though on how much a bank will insure or how much the FDIC program will insure. Today it stands at $250,000 per depositor. So if I have 250,000 on deposit at a bank and that bank fails,

 

I’m going to get all of my money back from the government, basically. Where we see some issues is people maybe either know or don’t really care or don’t know or don’t care that there could be, ⁓ you know, if you hold more than $250,000 at a bank that there’s risk associated with that. ⁓ And a lot of people don’t see that what that risk is, but I got some stats. I think it’s important to understand this from the FDIC.

 

On average, over the last 10 years, about five banks fail every year. So it’s not like this never happens. It happens every year, pretty much. We have bank failures. Now, they tend to be smaller banks. But if you have a local bank in your community and you’ve put money there, if you have more than $250,000, you have risk there that if you had $500,000 at that bank and it failed, you might lose half your money. You may not get half your money back in a bank failure. Where it really was pronounced was

 

during the financial crisis. So while we’ve averaged about five the last 10 years, in 2009, 140 banks failed in the US. In 2010, 157 banks failed in the US. These were not all just small banks either. I Washington Mutual, I believe, was the top 10 bank at that time and basically failed. So I think these are, there’s another one, Silicon Valley Bank is a more recent bank that was in the news.

 

That was more of a bank ⁓ out in California. A lot of depositors from tech companies or from tech companies and whatnot, private equity funds, also failed and there was issues there. So I think it’s just something for everybody to consider is if you are investing in a bank or if you have your cash in a bank, do you have more than the FDIC limits? And if so, be careful. You might think, I’ll just take it out if there’s ever an issue.

 

Usually when these bank runs happen, they happen very quickly. You have to, you know, and on top of that, where do I put it? Basically, you know, there’s, there’s a lot of decisions that have to be made in a very quick amount of time. And the likelihood is, is that you may not realize it till it’s too late.

 

Why Banks Love Your Idle Cash (9)

Marcus Schafer (22:13)

It is weird to say, but this is actually Nobel Prize winning research. And essentially what it says is there is this natural risk because the purpose of a bank is to take short-term deposits and lend them out for the long-term. So if anything happens to those short-term deposits, things can crumble really quickly, which to your point is why the government has ⁓ these insurance programs, but things like social media, et cetera, potentially speed up

 

some of this stuff. And so there’s just this natural tension. And by the way, there is something that you could do. People are really smart. And one of the things we encourage people to do is think about investing in a certain cash management product, that what it can do is, let’s say you have $2 million in the bank, it can loan that out to a bunch of smaller banks and

 

Each individual account will stay under that limit, but you will be protected at a higher limit. Now, the benefit is you only see one bank account, right? They’re the ones doing all this intermediary work behind the scenes. And you as the investor are going to get the protection as well as potentially higher returns. We talked about what is the business of a bank. I think it’s also helpful for people to recognize that

 

A lot of companies are banks that you might not think, meaning brokerage firms where you hold your money oftentimes are banks. One of the key ways they make money is by paying you lower interest and loaning that money out at higher interest. ⁓ If you’re invested in a Schwab account or another one of these brokerage firms and they’re popping up, Robinhood just launched.

 

bank account, essentially, they just got a billion dollars in deposits, Wealthfront just went public, and most of their revenue comes from banks, even though they’re all about robo advice. There’s a reason why these companies are maybe not incentivizing you to become fully invested. And I know that’s challenge you and I kind of fight all the time.

 

Pat Collins (24:28)

Schwab is a great example. I’ll just use that because it’s a company that we often have our clients have assets at. It’s probably one of the, it’s the largest in our industry for our registered investment advisors for custodian services for our clients, custodial services. And, you know, being a public company, we can go and look, see where they make their revenue. But you would think Schwab makes most of their revenue through investment products that they sell, custodial services, things like that. In fact,

 

Uh, nearly half of their revenue comes from their bank suite deposit, which is basically getting you to put your money into a bank product that pays you almost nothing. And they can yield it out because they do have a bank. They can loan it out, sorry, at higher rates. And so, um, this is a, uh, a few things I want to talk about on this. This is a fight that we continue to, you know, kind of.

 

battle with these custodians about for our clients on behalf of our clients. So these ⁓ larger institutions like Fidelity and Schwab, they are trying to force every cash deposit that comes in, dividends, interest, deposits that you make. They want to get it into this low yielding bank account. That’s the sweep. They were able to just sweep it into that. We are at Greenspring’s level is doing everything we can to push the money back out of that into higher yielding and ⁓ investments.

 

Now it takes a lot of manual effort to go do that. They don’t make it easy, but we think it’s important obviously to earn higher yields. I think it’s just as an aside, it’s an example because the other interesting thing about a Schwab or a Fidelity is they’re also advising clients. They have retail branches. And it’s just another example of when the people that are offering the products are also giving the advice, there are some incentives that you have to be aware of as an investor.

 

And that is that Schwab doesn’t have a big incentive to get you to invest in higher yielding products. In fact, they make half their almost half their revenue from you getting into their lower yielding products. So if you are working directly with Fidelity and Schwab, I’m not saying they’re bad companies, but their incentives are misaligned with yours. And that’s why we believe our model is a much better way to do it, which is we are just compensated by our clients. So we are.

 

figuring out ways to try to get our clients the highest returns possible because it doesn’t matter to us whether you’re in, you know, money market fund A, B, C or D, we’re not going to get compensated any differently from that. We’re compensated by our clients. this is kind of an aside. We’ve talked about this in prior episodes, cash is a great example of why working with an independent advisor, a truly independent advisor is important.

 

Marcus Schafer (27:10)

I thought about doing some research for this, it shocked me like, I wonder why Vanguard is my source. Oh, maybe it’s because they tend to be more aligned with investor interests and that is something that they’re highly aligned to. If you haven’t, Pat, this is just a for fun research project on the weekend for you. Read the conflicts of interest statements for these big custodians that also offer advice.

 

and the compensation guidelines that they have for their advisors in terms of, you get paid this if somebody’s in this and you get paid this if somebody’s in that. And it’s fully disclosed. So I’m confident the legal teams are very good, but this singular item, this is where you see a lot of the lawsuits happening in this kind of wealth management space where there’s a lot of questions and they are good questions to be asking over, are you really acting in investors’ best interests?

 

by the use of these cash sweep programs, while also understanding that if trade fees are zero, which is the direction they’re moving to, and there is a benefit to investors, right? Like it is a benefit to have things online and there’s good things that Schwab and Fidelity and the big custodians are providing, they need to be compensated for that. There’s these questions around what is the potential benefit.

 

that they provide, right? So there’s a cost and there’s a benefit and let’s go figure out the best way to do it. This is what we’re talking about though, in terms of there is opportunities to increase yield through things like instead of a savings account, a high yield savings account, because the liquidity differences, how easy it is to move your money around, it just doesn’t matter quite as much. And there’s some really good high yield savings accounts that can kind of pool, do what I was talking about, which is

 

put money in different smaller banks and act as that intermediary. Getting out of a bank sweep into a kind of money market fund, a traditional money market fund that really, by the way, doesn’t change your liquidity preferences. We were talking with a potential client yesterday who has done a lot of little things to be in amazing position. $34,000 was the annual

 

difference between the bank sweep and essentially a money market fund for the same risk protections. $34,000 is what was being ⁓ left on the table. Good, hardworking people that, I don’t know, I look at the statement and I’m like, I’m trying to find the number to figure out what do I got to go do research on. Pat, do you want to talk about that next level after we just get to yield and think about after-tax?

 

yield and what are some ways investors might want to think about that.

 

Taxes and After-Tax Yield

Pat Collins (30:09)

Yeah, absolutely. Using the tax code to your advantage when it comes to ⁓ your selection of cash vehicles is really important. So think it’s probably a good place to start is to say, how are these things taxed? So with bank interest, savings accounts, CDs, ⁓ money market accounts, they’re typically going to be considered ordinary income taxable at your highest marginal rate, just like you were to earn it in wages, both federally and at your state level.

 

So ⁓ you’re going to pay basically your highest rates on those. So ⁓ that’s OK. Obviously, you want to kind of figure that out. There are ⁓ other options oftentimes when you get into money market accounts that are investing instead of basically high yield savings, but they are taking your money and investing it in different products. So you’ll tend to see some that are going to be similar to a bank product where they’re investing in

 

corporate bonds and different types of securities that are going to be fully taxable. But you’ll also see sometimes opportunities to invest in treasury money markets. So what they’re doing is they’re just taking your money and investing in treasury bills or some sort of short-term treasury, basically. Those are ⁓ bonds issued by the government. They have a different kind of part in the tax code. They have a different kind of nature in the tax code. So they will be fully taxable at your highest marginal rate federally.

 

but treasury securities are state tax free. So that’s your first step, I think, when you’re looking at this is, I in a high tax state from a state income tax standpoint? So I looked at, I did a simple example. Let’s say I’m in a high tax state like Maryland, New Jersey, New York, California, these types of states, and let’s say I have a million dollars of cash.

 

And I want to invest in a money market. Basically, I want to keep that money in cash for whatever reason. Let’s just say I can earn three and a half percent. And what we’re finding now is treasury treasury money markets and regular traditional money markets are yielding about the same. They’re both around three and a half percent. So in both cases, I’m going to earn about $35,000 of interest, assuming the interest rate stays the same over the course of a year. If I am investing in just the traditional, ⁓

 

⁓ money market fund, I’m going to net after I pay all my taxes federally and state, about $18,550. That’s kind of the estimate. If I invest in a treasury money market, I’m going to net $22,050. It’s a difference of $3,500. So just a simple decision of which money market fund do I select in this case could save these thousands of dollars.

 

understanding that is going to be really important. You can take it a step further. And there are other money market funds that are out there that are basically what are called municipal money market funds. These are funds that are investing in municipal securities, meaning bonds that are issued by state governments, basically. The way those are taxed is they are going to be federally tax free. And

 

They will be free of tax in the state that they’re issued if you are a resident there. So if I live in Maryland, any municipal funds that have bonds that are issued out of the state of Maryland, that part will be tax free too. You have to do the math on those. What we’re finding today, I just did a quick math, some quick math. Fidelity’s municipal money market fund today earns 1.56 % yield. Their traditional money market fund is earning 3.37%.

 

So when you do the math after, even though that, that, that municipal one is tax free, even after I kind of get that benefit, the taxable equivalent yield, which would be like, what’s the equivalent if I have to compare it against the taxable ⁓ option, it’s about two and a half percent. So today we’re not seeing a tremendous opportunity to be in municipals. It changes a lot.

 

And I think that’s important to be staying on top of that or having your advisor stay on top of that. But the point in all of this is really to say that you have different options on how to invest your cash. It could be in different types of money market funds. We haven’t even talked about. You maybe do some laddering of very, very short term bonds, ultra short term bond funds. The point is, is that you’re going to do a full analysis to say after I pay all my taxes, what gets me the best yield, basically?

 

And I think the point of this is making sure that you do that analysis because it does matter.

 

Marcus Schafer (34:53)

Yeah, it’s do the analysis. The other thing you want to be thinking about is how often should I expect this math to change? And one of the things you see is there does tend to be a lot of variability in the kind of the difference between some of these accounts. So it’s how often do I come out ahead? But also you don’t want to really anchor yourself on one decision, set it, forget it. And sometimes it’s not the worst thing. I’ve seen a lot of research around

 

Are municipal bonds better or corporate bonds better in taxable accounts at really high tax brackets? And there’s a few variables that change that make it where, Hey, like municipals tend to be better, but it’s not the worst thing in the world to have some corporate bonds in a taxable account. And so you also want to be just thinking about. We don’t know exactly what’s going to happen in the future. Extra diversification. might lower returns, but it might increase reliability of returns. So there are.

 

⁓ There are benefits. think what’s fascinating about your example is you essentially compared the same vehicle structure, which is essentially the same risk characteristics to each other. so it’s like, you know how hard we work for 20 basis points on the equity side of annualized expected return? And then you look over at bonds and nobody wants to talk about it because it’s not as fun and cash is a little boring and the returns are just right there.

 

When Cash Optimization Matters Most

Pat Collins (36:21)

It’s so true. There’s not many things in, in finance where you can say, Oh, I can take the same amount of risk and just get higher returns essentially for free. Um, and so this is an area that’s like that, where it’s like, just optimize your cash. Um, now where does this really matter? It doesn’t matter as much if you are holding, you know, $5,000 of cash and everything’s invested. Your cash.

 

to be quite honest, is probably more of a preference item at that point is where is it most convenient for you to hold your cash? But we have a lot of clients for various reasons. And maybe it’s a good time to just talk about how much cash should you hold and what are some of the kind of preference items that you should think about. But we have clients that have millions and millions of dollars in cash for various reasons. And this is where it really becomes important is to make sure that you’re doing really, really ⁓

 

you know, optimize cash management basically for taxes, for yield, for risk, preference, things like that. But getting into kind of some of the main preferences, maybe we’ll just start very high level where I see kind of people have a preference for holding more or less cash. So I’d say that the number one people that hold, you know, a lot of cash, some of it’s irrational, just to be quite honest. It is just a pure feeling of comfort and safety.

 

that if I have less than X amount of dollars in the bank, I just get nervous. I like the security of having all this money sitting there in cash. That’s not optimal most of the time when there’s a lot of money sitting there. It probably comes from something way back in the past, somebody that just says, that’s just part of my personality. It’s hard to move people off that. Part of our job, I think, is to get people to understand what they’re leaving on the table when they do that.

 

A lot of times they’re not losing anything by investing at least some of that cash. But practically where I tend to see people have a higher level of cash and probably should is people that have very high variability in income. ⁓ So, you know, that tends to be sales jobs, business owners, a lot of times. These people that just have ⁓ massive swings in how much money they can be making. So they have maybe a lifestyle that is set at a certain level.

 

And their income just drastically varies off that. So there’s times where they need to pull on cash because they don’t have any income coming in. And then there’s times where they have massive amounts of cash coming in that they don’t need to spend. So those times of people tend to have higher balances than somebody that feels very confident about a steady job. Business owners is another one that I tend to see a lot of people have high levels of cash in, mainly because potentially their business is going to demand reinvestment in it for some reason.

 

You know, they go through a downturn. There needs to be something infused there. They don’t maybe have lending facilities, things like that. The other one I see is, you know, depending on how involved they are with their business, they may not fully or may have gotten burned in the past on taxes. So April comes around, their account says, by the way, you owe $180,000 of tax. And they say, I wasn’t planning on that. So they go through that cycle one or two or three times and they say.

 

Maybe that’s just hold a bunch of cash, you know, so I never get surprised by that thing, by a tax bill again. So I think there’s the tens of people I tend to see have high cash balances. The other side of it is kind of the exact opposite, which is people in steady jobs. know they have a very steady paycheck. They have a budget that’s very steady. A lot of times you’ll see people like that not needing to have as much cash in the bank because they know that there’s always this,

 

next month or next two weeks, I’m going to have another payment coming into my bank account. I know I have a very standardized budget, so I don’t need to hold as much cash. So I’ll stop there. See if you have any thoughts on these preference items.

Why People Hold Too Much Cash

Marcus Schafer (40:19)

You mentioned preference items and comfortability with your investment portfolio is really important. It’s what gives people the freedom to take a little bit more risk is feeling that ⁓ they have some peace of mind with their current cashflow. To your point, ⁓ as an investor, think what you want to try to do is set that cash target, but be very careful about the creep. I think this is something that…

 

we see, is, you know, well, I used to like a hundred thousand in cash, but now I have 200,000 in cash sitting there and I don’t really need it. ⁓ And so to your point, part of our job as advisors is explain, even if you fully invest that cash into your investment portfolio, since stocks have run up more than likely, you’re going to use that cash to essentially rebalance

 

into bonds. The bonds you’re going to be buying have very cash-like security at them. So it’s highly likely that even if you were investing that cash, it’s not really making your portfolio dramatically risky. It’s not saying, I’m taking this $100,000 and I’m putting it all in something that I expect to earn 10 % per year. But in any year, can be negative 20 % to positive 50%.

 

That’s not the swing that oftentimes is happening. So it’s helping people think through, all right, so you do want a little more safety in structure. What’s the best, let’s just walk through these incremental steps we kind of talked about earlier. At what spot do you land that’s comfortable? Let’s start there, recognize that benefit and then keep going. That’s like ⁓ an accumulator perspective. Maybe think about.

 

a retiree, what’s better to have money in the portfolio or just a bunch of cash that you can draw on?

 

The Liquidity Ladder

Pat Collins (42:16)

I think for someone in that kind of decumulation phase where they are taking money out of the portfolio, at least how we think about it is, and I think even the accumulator can think about it this way to some degree, which is how many months of expenses do I want to have in cash? And that’s a kind of, I don’t want to say rules of thumb because it kind of varies widely, but I would say that at least that metric is a good one to understand. And if you don’t know that.

 

You know, that’s probably a good first step is to say, well, what are my monthly expenses on average? Let’s just say they’re $10,000. So, okay, let’s think from a cash perspective in multiples of that. So, am I comfortable with two months of expenses sitting in cash? Okay, so I need $20,000 sitting in cash at all times. Anything above that, I should think about investing. We tend to see as people go into a kind of retirement phase,

 

I think for right or wrong, they tend to be wanting to have a few more months of expenses in cash. And that’s just an element of safety, basically. There’s trade-offs. I can get more months of expenses in cash. I’m going to earn lower returns. But I also know I have kind of ⁓ guaranteed ⁓ cash here to pay my expenses for six months or 12 months or whatever it may be. Part of that’s preference. Obviously, if you get too far extreme on either side, it can be somewhat detrimental.

 

⁓ So trying to kind of get that right size, I would say most of our clients tend to be around three months. ⁓ But there’s wide ranges there ⁓ in how much cash we keep. The other thing I just want to touch on, it’s doesn’t really fit in the accumulator or decumulation phase. But the example of, well, I’m saving up for X, a down payment on a house, a car, things like that. How should you be thinking about cash there? Well,

 

You know, one of things that, you know, we’ll tend to see is people just are saving money in a checking account or a savings account. It’s like, that’s your mark for, you know, for my, for my, our new house that we’re going to buy. And then when we ask when you’re going to buy that, it might be, well, somewhere maybe three to four years, three to five years. We’re still working on building that up. That’s another example of where you can try to optimize that. If you’re just putting that into a savings account, even a money market may not be the best scenario there.

 

What we haven’t talked about, and I think it’s another risk associated with holding very short-term investments like cash, is what I would call reinvestment risk, which is cash is happening like when you invest in a money market, they’re basically trading overnight bonds, essentially. So it’s very, very short-term. The risk is that the rates that they’re charging or that you’re receiving go down over the course of the next two days, five days, 10 days.

 

We’ve seen that over the last year. The Federal Reserve has cut interest rates. You’re getting less on your cash. So you have this risk that when you reinvest back into this money market, you’re going to earn less and less. So one way to kind of counteract that will be to choose maturities that align with your goals. So if I’m going to buy a new house in three years, every time I put a chunk of money into kind of that savings vehicle, maybe I should pick a T-bill, a treasury bill.

 

that matures in three years and aligns with when I’m going to buy that house. So now I’ve locked in a rate and I don’t have reinvestment risk anymore. If rates go down, I’m still fine. I’m going to earn the same rate that I earned right when I bought that security. it’s something to think about. Obviously it can work the other way. Rates can go up and you can make, you you can do a little bit better if rates go up. But for the certainty of when you know you have something being purchased,

 

A lot of times our clients like that idea of having some certainty around, want to earn, yeah, I’d like to guarantee right now three and a half percent on all these investments I’m making to try to buy this house in three years.

 

Marcus Schafer (46:16)

Yeah. And that’s assuming that the U S government is as strong as it is. To your point, we kind of call this the liquidity ladder, right? So you kind of have, Hey, what’s my daily expenditures? This is real cash that people, you know, when you think about cash, what is the purpose? It is so I can take this dollar and buy something with it. That’s kind of that first ladder. Then you have the second, which is kind of this emergency fund concept. ⁓ then you have this third, which is a very specific goal.

 

And in my experience, very specific goals kind of outside of two years. I’m not sure they’re very specific anymore, right? Because anything inside of two years, hey, I know I’m going to buy into a business on this date, everything else kind of, ⁓ And that’s maybe where I would start thinking about different funds or investing into a model because you know, it’s going to happen.

 

think it’s going to happen. The time period is a little bit uncertain, and there’s just chances that it’s not going to happen. So that liquidity ladder, I think, is a helpful framework for people to just to think about.

 

Pat Collins (47:30)

I think it’s a really good point that you made about outside two years or so, is it really, do you really have a very specific goal or is this just kind of more of like a wish dream type thing? Hey, we want to do this. We don’t know. One thing to also think about as you’re making those decisions, let’s say I want to buy a second home. I don’t know if it’s two years, four years, five years from now. ⁓ You know, how, how much certainty do you need to have on that date and the amount?

 

And if you’re willing to be a little bit more flexible to say, I could invest this money maybe in some sort of balanced type of strategy. And I have to recognize that there could be losses over the next three years. And if that happens, I’d be okay with that. Like right now, like I’d be okay. could, I could hold out for another few years basically, or I could, I could deal with it. Or I maybe we’d just delay buying the house or buy a little bit smaller house or whatnot.

 

Because I know the other side, that’s the risk I’m taking, but the other side of it is I could have a lot more money. I wouldn’t have to save as much over the next few years. So these are the trade-offs you have to think about as far as short-term expenditures that are coming up. Do I put it in cash? Do I invest it? There’s not a right answer for it. A lot of it depends on the goal, how certain you want to be. But ⁓ I think it’s a really good exercise to go through and to think about, do I need to have that much certainty? If I don’t need that much certainty, I probably have

 

potential to be able to have a lot more money three years from now if I invest in something else.

Action Steps for Investors

Marcus Schafer (49:00)

It’s just weighing certainty. The action items I think investors should take from this. Two things, you want to be thinking about, how much do I have in cash relative to my expenses or potential expenses, right? In your case about the small business owner, think about that concept and then go find the interest rate you’re receiving on that and ask yourself, am I a

 

High tax, is my tax return high? Right now it’s tax season. this is kind of, your marginal bracket not your effect? Is your marginal not your average? Is your marginal rate high? That’s kind of the last bucket that you’re going to be taxed in. And then look at those three numbers and just ask yourself, hey, are these the numbers that Marcus and Pat were talking about? And if they are, reach out to somebody or find a way to kind of do one of those

 

incremental movements, get yourself in a better spot than you were before. hopefully we can, nobody listening to this will buy the Capital One savings 360 instead of the performance savings because obviously performance in retrospect is so much better.

 

Pat Collins (50:17)

Yeah, I couldn’t really have said it better myself. These are all very kind of what seemed to be very small decisions, but they can add up to big results, especially over time. And especially if you hold larger cash balances. So if you are holding a lot in cash, these are really, really important decisions to kind of think through. I’d say, ⁓ you know, the attention to detail on these items can lead to thousands of dollars of difference in even in just one year over

 

10 years, 20 years, it can really matter. So take the time just to kind of dig into this stuff, evaluate where you’re at, optimize it. Hopefully you’re gonna be in a better spot.

 

Marcus Schafer (50:56)

Great, thanks Pat.

 

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Sources

Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.

Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.