Squeeze More Out of Cash Accounts

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. With cash yielding next to nothing, many investors are wondering about where to go for more yield.

Joining me to discuss that topic is Gary Zimmerman, whose firm helps high net worth investors maximize the yield on their cash accounts.

Gary, thank you so much for being here.

Gary Zimmerman: Thank you for having me, Christine.

Benz: Let's talk about the key reasons that investors might want cash in their portfolios. They might want an emergency fund, for example. Are there any other reasons to have cash holdings?

Zimmerman: Certainly. In fact Americans right now are sitting on quite a lot of cash. The average American household has about 40% of their net worth in cash today. Even among households with larger amounts of money--households with more than $1 million of investable assets--are sitting on about 31% cash. So there's a heavy allocation of cash, and I think your question is a good one, which is why are people sitting on so much cash?

Part of it, I think, is the traditional reason, which is that people are worried about extraordinary events in life: a job loss, medical expenses, that sort of thing. So there's a certain amount of reserve that people like to hold to keep themselves comfortable. Another reason that I think a lot of households are sitting on more cash than they historically have is that people have rotated out of certain asset classes.

I know personally I divested all of my fixed-income holdings about a year and half ago, with rates seeming that they were only going to go up and so bond prices will only go down. That cash, while it's no longer in fixed income, you may not want to reinvest that in equities or real estate or other asset classes.

The third reason is more tactical, and I know different people have different views on tactical asset allocation. But if you think back to the financial crisis, there are a number of people who said, if I'd only had extra cash on the sidelines, then I would've been able to buy when the market was at very distressed levels. I think there's a portion of cash holdings that are being held for that purpose.

Benz: The dry powder argument.

Zimmerman: Exactly.

Benz: There is obviously an opportunity cost, though, to holding too much cash. Even this year, a lot of people thought, interest rates are only going to go up, and in fact yields have come down, and that's been good for bonds.

So how do investors navigate this question of how much cash to hold? If they are trying to be prudent, maybe trying to keep a little bit of dry powder aside, what are some rules of thumb that people can use to make sure that they are not holding too much?

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Zimmerman: It's a very personal decision, and that's part of the challenge. Each person has a different risk tolerance; each person has different needs for cash. Some people are sitting on excess cash because they're saving up for a major purchase, like to purchase a new home, that sort of thing. We as a firm don't take a view as to how much cash someone should hold. Our thought is that simply for whatever amount of cash you've chosen to hold, you ought to be earning as much as possible on it.

Benz: Your firm, Max (maxmyinterest.com is the website), the goal is to help people maximize their cash holdings to get the best possible yields that they can get. But first, how do you define cash? I know there are true cash accounts, as well as some sort of quasi-cash accounts. Where do you draw the line when you're thinking about cash?

Zimmerman: The way I think about it is that cash is something that you hold because you want it to preserve value. It's a sort of risk-free investment, and you want it to be liquid as well. So cash might be the money you keep in your checking account or in savings accounts. There are other cash equivalents or near-cash equivalents like money market funds or certificates of deposit, and those are a little bit different than cash. But they all fall into that same general allocation.

Benz: Money market mutual funds would be a little different in that they are not FDIC insured at any level?

Zimmerman: That's right.

Benz: I just want to spend a second talking about them, because the SEC recently issued a new set of regulations regarding money market funds that will allow the net asset values of institutional money market funds to fluctuate to reflect the true values of the underlying holdings. Do you anticipate that this has any ramifications for individual investors?

Zimmerman: You are right, Christine. For institutional money market funds, they will be able to so-called "break the buck," as the Reserve Primary Fund did during the financial crisis. For retail investors, the implications of the new SEC ruling are a little bit different, because what the SEC has said is that money market funds will be able to prevent investors from withdrawing all of their money from those funds in periods of financial stress.

To me, that removes some of the liquidity from money market funds, particularly at the time when you might need it most. From my point of view, money market funds will start to look a little bit less like a pure cash equivalent.

Benz: Let's get into some tips for people who do have cash holdings. As you know, yields are very, very low. What are some ideas that you have for people who are attempting to wring out the best possible yield that they can get on their cash holdings?

Zimmerman: We like to optimize everything in life, and one of the things that I became focused on was the market for cash--the money that people have on deposit in the bank. Many people have been extremely frustrated by the fact that the yields at banks have been close to zero for so long.

What we've developed is an automated cash optimization tool that users can use; it's very simple. What it does is, it monitors interest rates at some of the leading online banks and helps investors reallocate their cash to the banks that are paying the highest yields at any given point in time.

Benz: So in general, do you find that the online banks tend to have more favorable yields than would be available at a typical brick-and-mortar bank?

Zimmerman: They do, and the reason is very simple. The online banks--and these are leading financial institutions like GE Capital, American Express--these online banks don't have physical branches, and because they don't have physical branches, they don't have to pay for real estate or the air conditioning bills, or for tellers or security guards. And because of that, they have much lower operating costs.

And what they've done is, they've taken a portion of those savings and passed them on to depositors in the form of higher rates. So while a typical brick-and-mortar bank account might pay zero or maybe 0.1%, the online banks are paying 0.75%, 0.8%, 0.9% in interest.

Benz: Some investors might have … some trepidation about dealing with a bank where they can't go in and visit the branch. How can they get past that mental hurdle of dealing with an online-only bank?

Zimmerman: In our system, we focused only on financial institutions that have great brand names, great customer service. These are firms like Barclays, American Express, GE, Ally Bank, and Capital One 360, and when dealing with those institutions, we know they have a good track record of customer service, that they are accessible.

Also, all of these banks are FDIC insured. The first $250,000 that a depositor keeps at those banks is backed by the full faith and credit of the U.S. government. And the way that our software works is that by default we keep depositors below $250,000 in each of those banks.

Benz: Another thing that I know that some of our Morningstar.com readers have been enthused about is using CDs in lieu of accounts where they can get that daily liquidity. Do you think that that's a viable idea as well?

Zimmerman: The interesting thing about CDs is that they are intended to pay a higher yield because you're locking up your money for longer periods of time.

Benz: Exactly.

Zimmerman: And some of the online banks do have compelling CD rates that are slightly higher than the demand deposit rates, but not much higher. But if you look at the traditional brick-and-mortar banks, even on a five-year CD, you are earning a fraction of what you could earn with regular demand deposit accounts at an online bank. So, from my perspective, it seems I would rather have full liquidity and full access to my money and earn a higher rate at an online bank rather than buy a longer-term CD product.

Benz: I'd also like to cover some of the pitfalls that can befall people who are navigating their cash holdings, attempting to maximize their cash holdings. Are there any cash options that tend to be notably bad choices?

Zimmerman: To me, sitting in a checking account earning nothing is a pretty bad choice. Now, checking accounts are great, and in fact our system is centered around checking accounts. So, we don't change the way that people interact with their checking account at all. But that's really a good place to store the money that you need on a month-to-month basis, not the excess cash that you might be holding for more strategic reasons. And because bank accounts tend to pay a lower rate than the rate of inflation, you're actually losing real purchasing power every day just by keeping it in a regular account.

Benz: How about brokerage sweep accounts? Those have always had the knock [of being] a lousy place to put your cash, and you should be proactive and get it out of there.

Zimmerman: Well, again, sometimes it's valuable to have cash sitting in the brokerage accounts, so that if you do see a buying opportunity, it's right there and you are ready to pounce on it. But those accounts do tend to pay either next to nothing or nothing on cash right now.

Benz: You have to weigh the convenience factor and your need for money against the yield consideration?

Zimmerman: That's right, and part of what we've done with our system is that all of that cash is available on very short notice and certainly fast enough to clear a trade. So, there is no reason why you couldn't keep it within the Max system and earn 80 or 90 basis points, that's 0.8% or 0.9%. And then when you want to make a trade, pull it out and send it to your brokerage account.

Benz: Gary, thank you so much for being here to discuss what I think is often a really under-discussed part of investor portfolios.

Zimmerman: Thank you very much, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.