Why Is Your Cash In The Bank?

Why is your cash in the bank? This question may sound absurd… where else would it go? Under my mattress? The truth is, few people understand bank deposits and bonds well enough to know that they have other options, and those options may actually (at the moment) be much better.

Typically, people keep money in the bank for three reasons: safety, return (interest), and accessibility. In the current environment, bonds actually beat banks on two of those three criteria and aren’t far off on the third.

SAFETY - Treasuries are even safer from default than bank accounts.

This is especially true if you have a large amount of cash. Don’t get me wrong, FDIC insured banks are a very safe place to keep your money. The FDIC automatically insures up to $250,000 per depositor with the full faith and credit of the United States government. However, above that limit, cash is only secured by the faith and credit of the bank institution itself.

In contrast, every treasury bond is backed by the full faith and credit of the US government with no limit.

What about all that debt our government is racking up, how can I trust that they won’t default? I won’t get into this argument other than to say that the US government is almost universally considered to be the least likely institution in the world to default. Further, if you don’t trust the US government to pay their debts, you shouldn’t trust FDIC insurance either. Remember, FDIC Insurance is just a promise by the government to pay depositors (up to $250k) if the bank fails to do so.

The net out is that for the first $250,000, banks and treasury bonds have essentially the same risk of default and above $250,000, treasury bonds have less risk of default.

RETURN - Bonds (finally) offer a decent return while interest paid by many banks has hardly increased.

As of 11/10/2022, the average savings account yielded 0.18% APY (per bankrate). Fortunately some banks pay a higher rate up to 3% or 4% but typically the amount allowed to earn this higher rate is limited to $10,000 or $15,000. These can also come with obnoxious requirements to have enough direct deposits or debit card purchases. CD’s are better, yielding on average 1.15% with the best available rate at 4.1% per bankrate.

In contrast, as of 11/22/2022, 1-month treasuries yielded 3.97% and 1-year treasuries yielded 4.75% (per treasury.gov). Unlike many high interest bank accounts, there is no limit on how much you could invest at those rates and no special rules or hoops to jump through.

ACCESSIBILITY - Bonds can be sold and converted to cash in a matter of days.

It’s hard to beat a bank account for convenient storage and access of your cash. That’s what modern checking and savings accounts are for. However, this convenience and accessibility comes at a price. Because you can demand your cash from the bank at any time, they must keep a large amount of money in reserve. They can’t lend or invest those reserves which means they can’t generate profit from them. This is at least part of the reason banks offer pretty stingy rates on your accounts or cap the amount that can receive a high interest rate (think LMCU or Consumers Credit Union).

CD’s take a different approach. You promise the bank you won’t touch your money for several months or years and, because they know when you will receive your money back, they can use your deposit to lend, invest, and otherwise make money. In return, they pay you a higher rate. The major drawback is the contract you make not to touch your money until the term is up. Your money is essentially locked up so you better know you won’t need it until the agreed-upon date.

This is where short term Treasuries at today’s rates shine. There is a large and highly liquid market for US treasuries, meaning they can easily and quickly be sold and turned into cash if needed. This process should take only a few days. So, not only do short term treasuries currently have a higher return than CD’s, they’re a much better investment if you may want or need your money within the next few months or years. Some typical situations that require this are cash set aside for a home purchase or business investment, for a future tax bill, or to generate some return while buying into the stock market over time (dollar-cost-averaging).

The value of your bonds can go down if they’re not held until the end of their term.

This is a major difference from bank accounts or CD’s where the value of your account doesn’t fluctuate based on markets or interest rates. When interest rates rise quickly as they have this year, bond prices drop. This is because new bonds being issued as rates continue to rise pay a higher rate than bonds issued 3 months, 6 months, or 1 year ago. Naturally, if you want to sell your old bond that’s paying a lower rate than bonds issued today, buyers demand to buy them at a discount so that their total return if they hold the bond until the end of its term is the same as a bond purchased today.

Here’s the good news, this risk of your bond dropping in value only exists if you sell it before the end of its term. If you hold your bond until it matures you know exactly what your return will be because the US government will pay you its initial value plus your interest. This is one reason holding actual bonds can be preferable to bond mutual funds or etfs. Bonds are more complex to buy and sell but you can lock in specific terms, return rate, and you are in control of if and when to sell a bond or hold it to maturity.

Some more good news, short-term bonds for 1 month, 3 months, or 6 months change much less dramatically in response to interest rates than longer term bonds like 10-year or 30-year treasuries. AND, to top it off, short term bonds are currently paying higher rates of return than long-term bonds (thanks to an inverted yield curve which is a somewhat rare phenomenon and a topic for another time).

Lastly, this price movement can also work for your benefit. If interest rates drop, the value of your bonds will increase meaning you could sell them prior to maturity for a better return than you expected. The net out is that if you’re willing to hold a treasury bond until the end of it’s term - you know the minimum return you will receive, the only risk of loss is if the US government defaults on its debt, and your bond has the potential to do better than expected if interest rates drop.

Don’t just throw away your investments and strategy to go buy short-term bonds!

Yes short-term bonds are currently a great option FOR A SPECIFIC PURPOSE. If you’re looking for a place to safely park cash that you may need in the next few months or years and make a decent return… short-term bonds sure seem to beat the bank. If you’re saving for a far-off goal, 4% to 5% return likely isn’t the best you can do. Over long periods of time, stocks and long-term bonds have historically outperformed short-term bonds. If you have a strategy, stick to it. If you’d like a strategy, please reach out. You can reach me by email at ryan@ffadvisor.com or cel phone: 616.594.6205.

Footnotes

Bank & CD Rates per bankrate on 11/22/2022

Bond rates per Daily Treasury Par Yield Curve Rates on treasury.gov - 11/22/2022