This may sound like a simple task, but in the wake of bank failures like Silicon Valley Bank and Signature Bank,
choosing where to deposit your money should be an important consideration.
First, let’s determine why you need cash as part of your financial plan.*
Operating budget
Think of yourself as a business. A business needs cash to support its operations (payroll, rent, software, cost of goods/services, etc.). For you, expenses might look a bit different (student loan repayment, kids’ expenses, food, shelter, etc.), but in the end, you need enough cash to pay off your expenses every month, otherwise you will have to leave a balance on your credit card and pay a high interest rate.
Emergency fund
I’ve discussed this in previous blog posts, but having a well-funded emergency account is often the first thing you should be focusing on when building a financial plan (other than maybe paying high-interest credit card debt). The reason is we never know what the future holds, and being prepared with enough cash on the sideline could make things a lot easier in the event something happened.
Think about a situation where you lost your income for several months—either because you were part of a layoff, or because you cannot work due to an injury or sickness. If you have enough cash to support your basic essential needs, you might not be rushed into taking a new job that isn’t a good fit, or you might take more time to recover fully from your injury/sickness. Additionally, you would avoid having to rack up debt on your credit card.
The recommendation of how much to keep in your emergency fund varies depending on your personal situation. If you are young and single and no one is dependent on your income, your emergency fund might not need to be as high—maybe you can get by with three months’ worth of expenses. But if you are the breadwinner of your family and you have children, you may want to keep around six months’ worth of expenses. If you are a solo practitioner and you are the sole income source for your law practice, one year of cash on hand might not be a bad idea.
Future short-term cash needs
Another reason why you need cash in the bank is for future short-term purchases or funding. For example, you may be planning to buy a house soon and you will need money for the down payment and closing costs. Or maybe you are a partner at a law firm, and you know you will need to buy into the partnership soon.
The key thing to determine is what your time horizon will be for this money. If it’s less than 24-30 months, keeping the money on the sideline might be the safest play, even if you miss out on some market return—think about the stress you would have if you saw your account balance going up and down every day and knowing you need that money soon. If you know you won’t need the money for at least 24-30 months, you could take some risk and invest the money in a moderate-risk portfolio. Two reasons why it would be okay to do so: (1) you historically get better returns in the market than at the bank, so your account has potential for higher growth; and (2) history tells us that the average bear market (stocks declining more than 20%) lasts around 9 months, so if your time horizon is more than 24-30 months, your money should have time to recover before you need it.1
Now that we’ve determined why you need to keep cash in the bank, let’s look at where in the bank you should keep it—because not all bank accounts are created equal!
Where to keep the money
Checking Account: For your operating budget, I recommend keeping about two months’ worth of expenses in a checking account because it’s the most versatile of all bank accounts (you can set up automatic payments, write checks, transfer money, withdraw cash, etc.). Checking accounts don’t generate much interest, but it’s okay, you have other accounts that serve that purpose.
High Yield Savings Account (HYSA): For your emergency fund and your short-term cash needs fund, an HYSA could be a great option. HYSAs typically offer better interest rates than regular savings accounts, so your lazy money would have potential for higher growth. This is true because HYSAs are frequently offered by online-only banks that do not have all the overhead expenses of brick-and-mortar banks. That said, most HYSAs don’t offer all the flexibility of checking accounts (automatic payments, check writing, etc.), so that’s why it’s still good to have a checking account. Note that HYSAs are also FDIC insured up to $250K ($500K for joint accounts), so if you have more than that in cash, you can open a new account at a different bank to make sure your cash is insured. An alternative to HYSA would be a money-market account.
Certificate of Deposit (CD): If you have a specific time horizon as to when you need your money, a CD might be an even better option than an HYSA because they will typically pay a higher interest rate. CDs offer a fixed interest rate for a specific period of time (e.g., 5% for 12 months). The caveat is they are not liquid, so if you need to withdraw money before the end of the term, you may need to pay penalties or forgo the interest you earned. If you don’t know what your specific time horizon is, an HYSA is a better option because it is fully liquid from day one.
1. Source: https://www.hartfordfunds.com/practice-management/client-conversations/managing-volatility/bear-markets.html-