balances

Interest Rates Are Rising: Here's Where to Keep Your Cash

Philip Brewer — Wed, 11 Apr 2018 08:30:05 +0000

These past 10 years, interest rates have been so low it just about didn't matter what you did with your cash. There was a certain convenience to that — you didn't have to move money back and forth between checking and higher-rate accounts, because they paid almost the same. As a bonus, you didn't have to track money market returns to be sure the rate your account paid was still competitive, because they all paid just a fraction over 0 percent.

That has changed. The Fed has already started raising interest rates, and will probably raise rates another three-quarters of a percentage point this year. Already, rates are high enough that it makes a difference where you hold your cash, and that difference is starting to get significant. (See also: How to Benefit From Rising Interest Rates)

Let's take a look at where you should be holding your money, as well as a few reasons why you need cash on hand.

What cash to hold

There are four main reasons to hold cash: liquidity balances, planned expenses, temporary holdings, and an emergency fund. The size of your temporary holdings may vary quite a bit from time to time, but the others have pretty specific parameters that it's worth being clear about.

Liquidity balances

Your income arrives in chunks that don't precisely match the due dates of your bills. Liquidity balances are the cash you keep on hand to smooth that out, so that you can pay each bill when it's due. Sizing the cash demands of your liquidity balances is easy: It's the total of all the bills that might come due between income payments. Once you know this amount, you can set it aside for when you need it.

Planned expenses

Everybody has some expenses that are not regular monthly bills, but are nevertheless known in advance. Some of these are regular, they're just not monthly: tax payments, insurance premiums, tuition payments, etc. Others are irregular, such as discretionary payments on things like home improvements, airfare for your vacation, buying a boat, etc. Regular or irregular, if there's a near-term payment to make, it's good money management to hold some cash to pay it.

Temporary investments

Sometimes you have cash that you've decided to invest, but that you aren't ready to invest yet. Maybe you don't know exactly where the money should go until the next time you rebalance your portfolio. Maybe you expect market conditions to improve. Maybe you're accumulating money to meet the minimum balance of some fund. Whatever the reason, until you're ready to invest, you're holding the money as cash. (See also: How the Risk Averse Can Get Into the Stock Market)

Emergencies

Your emergency fund is cash set aside to handle a financial crisis — a job loss, a medical bill, a home repair, etc. Having the money on hand means that you won't have to turn to credit cards or other forms of debt to get through your emergency. Experts often recommend an emergency cushion of three to six months' worth of daily living expenses. Your unique situation — such as an expensive medical condition or a high-paying job that would be difficult to replace — may call for a larger fund. (See also: 5-Minute Finance: Start an Emergency Fund)

Where to hold your cash

In the U.S., we have a complex history of rules related to ceilings on the rates banks can pay, special exceptions to those rules, and free-market efforts to get around those rules. There are a lot of different kinds of institutions that hold cash and a lot of different kinds of accounts available at one or another of those institutions.

Whatever sort of institution you choose, you still need to figure out what sorts of accounts to use for your cash. Here are the usual suspects.

Checking accounts

For most people, a checking account is their main gateway into the banking system. Their paycheck is direct deposited into their checking account, and most of their bills are paid out of their checking account.

Back in the 1980s and 1990s, banks had to pay reasonably competitive interest rates to pull in money to support their (highly profitable) lending. That became less and less true in the early 21st century, until the financial crisis put an end to it. At the moment, checking accounts pay so little interest that you might as well just ignore it.

That doesn't mean you shouldn't have a checking account — it's just no longer where you should hold your liquidity balances or your cash to cover planned expenses, until just a day or two before you need to make a payment. (See also: 9 Common Mistakes You're Making With Your Checking Account)

Reloadable debit cards

These are a relatively new invention, created for people who don't need (or can't manage) an ordinary checking account. As the name suggests, it functions as a debit card. There is usually some limited ATM access and some sort of bill-paying feature.

Once little more than fee-generating boondoggle for the banks, rule changes made them pretty fair for consumers a few years ago. Since these new rules went into effect, a reloadable debit card had been a reasonable place to hold your cash balances when rates were low, but now that interest rates are going up they're only reasonable for people whose circumstances make a bank account impractical.

Savings accounts

It used to be that you opened a savings account even before you opened a checking account. Now an ordinary savings account is almost pointless. At least at my bank, a savings account pays the same minuscule rate as a checking account, so I might just as well leave my excess cash in my checking account.

When you think about savings accounts nowadays, though, you're usually not thinking about a savings account at your local bank. You're thinking about an internet savings account. (See also: 6 Important Things to Look for in a Savings Account)

Internet savings accounts

These are just ordinary savings accounts, except they're at a bank that's willing to pay up to get your money, and that offers a convenient web interface for moving money to and from your checking account. The money moves by ACH transfer, typically in two or three days. This is quick enough to make these accounts very useful as a place to hold your cash.

Unlike a lot of other kinds of financial accounts (where the terms and conditions vary in complex ways), the terms and conditions of internet savings accounts tend to be relatively standard, making it easy for savers to compare one account to another and pick the one that offers the best deal. (See also: 5 Best Online Savings Accounts)

Money market funds

Money funds are a legacy of 1970s interest rate regulations. They pool money from shareholders, invest it in short-term securities, and share the return. Because they just share whatever return they get, returns go up quickly when interest rates rise. (Unlike savings and money market accounts, where banks that already have your money won't raise rates until they have to.)

Although very safe, investments in a money market fund are not guaranteed. In fact, one money market fund lost enough money during the financial crisis that it was unable to make investors whole. That prompted major players in the money market to simultaneously all try to get out of assets with even the slightest risk. Basically, that was the financial crisis.

Money market accounts

Created in the early 1980s as a carefully carved-out exception to interest rate regulations, money market accounts were created in a way that didn't cannibalize on checking or savings accounts (basically, they only allowed six withdrawals per month and only three of those could be by check). They had advantages over a money market fund: They paid an announced rate (instead of just whatever the fund could earn in the market), they were guaranteed to pay off at 100 cents on the dollar, and they had FDIC insurance. That's all still true. (See also: Money Market Accounts: Ideal for Emergency Funds)

Other possibilities

There are a lot of other places you might hold cash for the short term: Demand note accounts (basically an IOU from a major financial corporation packaged up like an internet savings account), cash management accounts (a money fund or money market account wrapped up inside a brokerage account), CDs, and Treasury bills.

Bottom line

It no longer makes good sense to just keep your money in your checking account — the simplest version of cash management. Now that you can earn a return that's more than a fraction above zero, the time has come to manage your cash more actively.

Simple, but not too simple

The easiest version of active management is just to shift most of your liquidity balances, near-term planned expenses, and temporary investments into some sort of higher-yield account.

Just do this: When your paycheck (or any other money) arrives in your checking account, transfer most of it to your higher-yield account. Two or three days before your bills need to be paid, transfer the necessary amount of money back to your checking account.

Not so simple

If you're into this sort of thing, you can get as fancy as you want.

If your finances are sufficiently under control, you can skip the step of having your income enter via your checking account only to be transferred to your higher-yield account. Instead, you can arrange to have your direct deposit go straight into your high-yield account. That gets you earning your higher yield a couple of days earlier, and potentially cuts the number of transfers you need to make in half.

Especially for expenses with due dates that are well-known but further off than this month, it may make sense to do something with CDs or Treasury bills.

It may be more convenient to keep your temporary investments closer to where the investments are going to be held — perhaps in a money market fund in the same family as the other mutual funds you hold, or one with your brokerage firm.

The possibilities are endless. But the time for just leaving your money idle in your checking account has ended.

Like this article? Pin it!

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Your Bank Took Away Free Checking. Now What?

Rachel Slifka — Fri, 02 Mar 2018 09:30:06 +0000

You are a financially responsible adult who has been a loyal customer of the same bank for years. Now you find that you've been hit with a random checking account fee. What gives?

If you're like most people, you keep enough in your checking account to pay the bills, but you don't store your life savings there. Unfortunately for you, many big banks are changing how they do things. Checking accounts that used to be free are now being charged a monthly service fee if they don't meet certain criteria, like minimum balance and direct deposit amounts per month.

So what are your options? If you've been hit with a monthly checking account fee, here are some things you can do. (See also: 5 Signs It's Time to Find a New Bank)

Ask your bank for an explanation

If you're finding new fees being tacked onto your bank account statement, you will want to go directly to your bank. Ask them what the fees are and how you can avoid them. If you've been a longtime customer, you may even have leverage to have these fees waived. In any case, find out what is required to avoid these fees altogether in the future.

At the very least, your bank should be helpful in working with you to solve this issue. Be sure they spell out exactly what criteria they require for a checking account and what charges they'll make you pay if you fail to meet their requirements. (See also: Are You Paying These 6 Unfair Banking Fees?)

Utilize direct deposit

To avoid a monthly checking account fee, your bank may require you to have a minimum amount directly deposited into your account every month. For example, this minimum may be $250 per month.

Banks like direct deposit because when you have money regularly deposited into your account, you are less likely to overdraft. So long as you have a steady job and your employer utilizes direct deposit, this should be a relatively simple fix. You can ask your human resources department whether you are eligible for direct deposit, or if you can change your current setup.

Keep up that monthly minimum

Does your bank require a monthly checking account minimum? If so, you will need to keep that minimum amount available in order to avoid additional fees.

Keep in mind, if the minimum is very high, your money could possibly be put to better use. Money in a checking account likely isn't earning very high interest, if it's earning anything at all. You could earn a better return by investing that money or using it to pay off high-interest debt.

Take a look and consider your options. If the checking account minimum is too high for your taste, you may want to consider finding a new bank.

Switch banks

Changing banks can be a hassle, but it's one that can be very worth your while. If your current bank is charging you more fees than it's worth, it's time to make a switch. There are still plenty of banks out there currently offering free checking accounts, many of which even earn interest. You have other options. Don't settle for a bank that is not meeting your needs. (See also: Switch to a Better Bank in 5 Easy Steps)

Like this article? Pin it!

This article is from Rachel Slifka of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

5 Surefire Signs You Have Too Much Debt

Denise Hill — Mon, 18 Dec 2017 09:00:06 +0000

Dave Ramsey once said, "Debt is dumb, cash is king." Truer words have never been spoken.

According to data from the U.S. Federal Reserve, the average amount of credit card debt per U.S. household is over $16,000. And even though debt and consumerism are the American way, staying up at night worrying about money doesn’t have to be the norm.

The ability to make the minimum payments on all your debts each month doesn’t constitute financial stability. Your credit card bills may not be keeping you up at night yet, but if you analyze your financial situation, you may find that you are closer to the edge than you think.

Here are a few warning signs that you have way too much debt:

1. Your debt-to-income ratio is too high

A long-standing rule of thumb says that monthly debt payments (excluding your mortgage) should not exceed 20 percent of your monthly net income. And while rules of thumb are a great gauge, don’t count on this one to be the final word concerning your relationship with debt.

The 20 percent rule is an overarching starting point for evaluating your debt, but it doesn’t consider your total financial picture or your level of income. For example, if your net income is $5,000 a month and you pay little or no rent, $1,000 in monthly consumer debt is manageable. However, if you only earn $2,000 monthly, pay $800 in rent, and have to shell out $400 for credit card debt — you are in trouble.

A better approach is to keep your debt-to-income ratio as low as possible. To stay out of the danger zone, financial experts believe that being at or under 15 percent is considered “safe,” between 15 and 20 percent is “at risk,” and above 20 percent is when sirens are blaring.

2. You can't afford living expenses without a credit card or loan

The dangerous trend of charging day-to-day expenses is becoming increasingly common.

A study conducted by NerdWallet found that household income has grown by 20 percent in the past 10 years, while the largest and most common expenses for most people — medical care, food, and housing — have outpaced income growth.

This is the primary reason why debt reduction is a must. It costs more to simply survive today than it has in times past.

Using credit for standard living expenses, such as gas and groceries, and not paying it off each month is a sign that you are headed for trouble. It could mean that your living expenses exceed your income or that you are living a lifestyle you can’t afford. Financial experts agree that you should only use credit cards to handle the day-to-day if you are paying the balance in full every month. (See also: Should You Pay Your Bills With a Credit Card?)

3. You keep dipping into your savings

Repeatedly dipping into long-term savings to make ends meet or pay for unexpected expenses (car maintenance, traffic tickets, doctor's visits, etc.) indicates that you may have an issue with liquidity and savings. You also probably don’t have enough money to truly handle a financial emergency.

Another good rule of thumb as it relates to savings is that you should have at least three to six months' worth of living expenses in an emergency fund. What constitutes an emergency are things such as a job loss or an unexpected medical expense. Your car note should not be paid from your emergency fund.

If you keep using your emergency stash for every unbudgeted expense, that is a red flag. You need to re-evaluate your budget and spending. You may need to find cheaper housing or transportation and cut some of the little things that nibble away at your budget such as shopping, eating out, and going to the movies. (See also: 7 Easy Ways to Build an Emergency Fund From $0)

4. You can’t pay your credit card balances in full each month

The goal with credit cards should be to pay them off every month. When you only make the minimum monthly payments, most of the money is eaten up by interest and very little goes to paying the principal. Carrying a balance from month to month is costing you.

For example, let's say you owe $5,000 on a card at 17 percent interest with a minimum monthly payment of $100. If you can’t afford to pay more than the minimum, you could be paying that bill for 27 years. And the icing on the cake? Over the lifetime of the debt, you would have paid double the original amount because of interest charges.

If you can’t pay your credit card in full each month, at least pay more than the minimum while keeping the balance as low as possible. You should never carry a balance of more than 30 percent of your credit limit on any one card or in total. (See also: The Fastest Method to Eliminate Credit Card Debt)

5. You have to rob Peter to pay Paul

If you are constantly missing payments, paying things late, or using one credit card to pay another, you are on a high-speed train to financial disaster. Things will only get worse from here if you don’t make some adjustments — quick.

When you use your credit card to pay on other forms of consumer debt — especially other credit cards — you spend more money due to fees you incur. Most credit card, mortgage, and education lenders don’t allow you to pay them directly using a credit card. You have to go through a third-party service or get a cash advance in order to pay with your card, and both of those options come with hefty fees.

The deeper you get into debt, the faster it mounts. If you find yourself in a situation where you are drowning in credit card balances, you need to take action.

Step back, evaluate your situation, and make a plan. The first step is developing a realistic budget and eliminating unnecessary spending. You’ve got to be brutal and savagely cut the things you don’t need.

The next step is to devise a debt elimination plan. This may require you to contact your lenders to renegotiate repayment terms, and you may have to find a way to increase your income. A few options for generating extra income include selling stuff you don’t need or can’t afford, getting a side gig, or even downsizing. The point here is to regroup and take control of your debt instead of allowing it to control you. (See also: 7 Easy First Steps to Paying Off Debt)

Like this article? Pin it!

This article is from Denise Hill of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

6 Scary Facts About Credit Card Debt

Dan Rafter — Wed, 21 Sep 2016 09:01:03 +0000

We all know that credit card debt is the worst type of debt that you can carry. That's because of the high interest rates attached. If you don't pay off your credit cards in full each month, the debt you owe can quickly skyrocket.

But even though credit card debt is scary, this hasn't stopped many consumers from racking up thousands of dollars of it.

As fall arrives and Halloween looms, are you ready for a real scare — at least of the financial variety? Here are six facts about credit card debt that should spook consumers who don't pay off their card balances every month:

1. There's Too Much Credit Card Debt Out There

Credit card debt is like one of those unstoppable slashers from 1980s horror movies: It's hard to get rid of. That explains why, according to a report on consumer credit by the Federal Reserve, the total amount of revolving debt owed by U.S. consumers stood at a staggering $953.3 billion as of May of 2016.

The Federal Reserve predicts that this debt, which is made up mostly of credit card debt, could hit $1 trillion by the end of the year — the highest this figure has ever been.

2. We're Not Paying Off Our Credit Card Debt as Quickly as We're Adding to It

Credit card website CardHub reported that during the first quarter of 2016, U.S. consumers paid off a total of $26.8 billion in credit card debt. That sounds impressive, right? Unfortunately, it's not. According to the report, that represents only 38% of the $71 billion in credit card debt that U.S. consumers added to their cards in 2015.

In other words, American consumers as a whole are paying off far less of the new credit card debt that they are adding.

3. Too Many of Us Owe Thousands of Dollars in Credit Card Debt

That figure above is scary. But what's more frightening is the average amount of credit card debt that Americans owe. This figure is hard to pin down, because how high it is depends on whether you include consumers who use credit cards but don't carry a balance each month.

But here are two particularly chilling credit card statistics: In July of 2016, CreditCards.com reported that the average U.S. household that has credit card debt owes $9,600. The average credit card that usually carries a balance has $7,494 on it as of July of this year.

4. Credit Card Interest Rates Are Still Far Too High

Credit card interest rates remain downright scary. According to Bankrate, the average variable interest rate on U.S. credit cards stood at 16.10% as of August 17 of this year. Even scarier are the penalty interest rates that credit card companies can charge you if you're late on paying your bill. Your interest rate could soar to 28% or higher.

5. It Can Take a Frighteningly Long Time to Pay Off Credit Card Debt

As anyone who has struggled with credit card debt knows, eliminating that debt takes plenty of patience. If you make only the minimum payment each month, it can take you a decade or more to pay off your debt. Consider these numbers provided by Bankrate: Say you owe $6,000 on a credit card with an interest rate of 18%. If your minimum payment is 4% of your monthly balance, it will take you 11 years and nine months to pay off that debt making only this required minimum monthly payment. You'll pay a total $9,474 to pay off that $6,000 debt. And this assumes that you won't add any new debt to your card during this time.

6. Making a Late Payment Will Haunt You

Paying your credit card bills late can have a frightening impact on your FICO credit score, the number lenders rely on to determine whether you qualify for loans and at what interest rate.

If you are 30 days or more late on your credit card payments, your card provider can report your late payment to the three national credit bureaus of Experian, Equifax, and TransUnion. A single late payment will stay on your credit reports for seven years. It can also cause your credit score to fall by 100 points or more.

Like this article? Pin it!

This article is from Dan Rafter of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: