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Where to Stash the Cash

Jason Stipp

Jason Stipp: I'm Jason Stipp with Morningstar. We talk a lot here at Morningstar about where to put your investment dollars; which stocks, which funds, which ETFs--but another important consideration is where to put those assets that aren't invested, or at least that aren't invested right now: your cash.

Here to talk with me a little bit about your cash holdings is Christine Benz. She's Morningstar's director of personal finance. Nice to see you again Christine.

Christine Benz: Hi, Jason. Nice to be here.

Stipp: So, over the last year, a lot of people have been spooked by the market, and all the volatility that we saw. A lot of them went to cash, or they got out of the market entirely is what we're hearing from a lot of our members.

We're not talking today about "You should be in all cash today, " or "You should stay in all cash." That's not really what we're addressing here today, but there are some general reasons why you might want to have a cash stake. So what are some good reasons, just rules of thumb, to have a little bit of your assets in cash?

Benz: Everyone should have some cash on hand, and I would say if you're still working, one of the key reasons is in case you lose your job.

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But you also want to have cash on-hand to fund any emergency expenses. So car repairs, health-care bills, anything like that, because the last thing you want to do, obviously, is resort to using your credit card to pay off those kinds of bills.You also want to avoid having to tap your long-term accounts, perhaps when they're still at a relatively low ebb, as you might say with your stock accounts right now.

Stipp: Sure, so you don't want to have to be forced to sell at a bad time, just because you needed a little bit of that liquidity.

Benz: Exactly.

Stipp: So, how much cash do you think you should hold aside, if you wanted to have that buffer in case of an emergency? What's a rule of thumb on that?

Benz: Well, the conventional financial planning rule of thumb had been three to six months' worth of living expenses held in highly liquid cash accounts.

After the recent recessionary period though, I think a lot of planners were probably looking at that number and saying that's too low. Would people really want just three to six months to find a new job in case they lost theirs? Probably they would want more.

The downside is, though, of having more than that in cash, is that yields are so low. So you don't want to have too much in cash. So I would say, anywhere from probably six months to a year in highly liquid securities probably makes sense for most people.

Stipp: So, speaking of yields, and yields are much lower perhaps than what people had seen in the past. There are a lot of different options for where you can put the cash. So, if I need to set aside maybe a little bit more money in case of a job loss, how can I maybe squeeze a little bit more yield out of some that money that maybe I wouldn't have otherwise needed to have in a cash-like investment?

Benz: It's a good question. So, in general, CDs will yield more than you would be able to earn on a money market account, or a money market fund. The downside of course, is that you do have to lock up your money for a period of time, but yields are generally higher than they are with those more liquid vehicles.

Another thing you could think about is if you've decided, "Well, I do want to have a year, give or take, in some highly liquid account," think about staking three to six months in those truly liquid investments (so CDs, bank accounts, checking accounts, money market accounts), and then put another six months in, say, a very high-quality short term bond fund. So, a fund I would like for that job would be Vanguard's short-term bond index, which is a very high-quality, low-cost portfolio.

Stipp: So you'd tier your cash-like investments for what you might need immediately, and maybe a second group that you invest and get a little bit more yield, but you were not going to necessarily tap into that as a first line of defense. Get a little bit of extra yield that way.

Benz: That's how I would think about it. Yeah, exactly.

Stipp: OK. Then, there's also bank accounts versus money market funds, and so what are some of the differences I should think about there? I mean, should I just leave it in a savings account, or do I have any risk in going to a money market fund, and how should I think about those two particular vehicles?

Benz: Well the key difference, and you kind of touched on it, is the FDIC insurance. So, in a bank-insured vehicle, so a CD, money market account, certainly a bank account or checking account, up to certain levels, you are covered by FDIC insurance. So your money is insured, and nothing could happen to it, assuming that you stay below certain thresholds.

Money market funds are not FDIC insured. So, there are no guarantees, but in fact, there haven't been many cases, there have been a few cases, but there haven't been many cases of funds breaking the buck, as they call it. So falling below a one dollar net asset value.

Stipp: So if I were very concerned about money market funds, if I was concerned even about that small level of risk, what might be some red flags if I were comparing options that might indicate, "Hey, this fund potentially could be a little bit riskier than another fund that's similar?"

Benz: Well, one thing I would think about is the very highest yielding money market funds. Not all of them are taking outsized risks, but the fund that broke the buck famously last year, did in fact, have the highest yield in our database at that time.

It also did not have super low expenses. So oftentimes when funds are able to have very high yields, it's because they have nice low costs, they don't have to invest in anything risky to be more competitive and to have better yields than the competition.

If a fund does not have low costs and has a very high yield, that could be a red flag that perhaps it's investing in more risky, short-term securities than other money market funds.

Stipp: Great. Well Christine, thanks so much for your insights. It was a pleasure talking to you today.

Benz: Thanks, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.