Last week we covered the topic of cash reserves and offered some advice on how to build an appropriately sized reserve for your business. We also alluded to the fact that in today’s extremely low interest rate environment it can be hard to find attractive places to invest those cash reserves. While some of you may be tempted to stuff cash underneath the mattress after taking a look at the rates on offer, there are better options out there that can help entrepreneurs earn a little something without compromising the safety of their investments.
While we’re not here to offer any specific advice about where to invest your cash—talk to your financial advisor about that—we can help to explain some of the options available in order to help you come up with a sensible overall approach to cash management.
The first step is to mentally divide your cash reserves into two buckets: one that you need to have immediately available and another that you can afford to have tied up for a certain period of time.
For the first bucket your options are going to be pretty straightforward, you’ll be looking at deposit accounts from FDIC-insured banks, which pay low rates but allow you immediate access to your funds. These include checking, savings, and money market deposit accounts. Note that money market deposit accounts are different from money market mutual funds, as the latter do not come with any FDIC guarantee. And with rates on money market funds currently as low or lower than those on savings accounts it may be best to avoid them. The FDIC currently provides savers with $250,000 in deposit insurance at each insured bank. If your reserves are greater than this, you should consider splitting them between two or more banks so that all of your funds are covered by the FDIC guarantee.
For the second bucket, the portion of your reserves that you are comfortable having tied up for a period of time, you might consider putting some money into certificates of deposit (C.D.’s). These typically offer higher interest rates than savings accounts, but you won’t have access to your money until the C.D. matures. C.D.’s come in maturities ranging from three months to five years—the longer the term the higher the yield—and are covered by FDIC insurance. You probably will want to split your money across C.D.’s of varying maturities, a process known as laddering. Laddering will ensure that you receive steady cash flows as the C.D.’s mature and will decrease the interest rate and reinvestment risks of your cash reserves. There are a number of good laddering calculators on the Web that can help you with the process.
You might also want to look at high-quality government and corporate bonds with similar maturities to the C.D.’s that you are interested in. These may offer slightly higher yields but are not FDIC insured (although U.S. Treasury securities are backed by the full faith and credit of the federal government). Keep in mind though that if you are forced to sell a bond before it matures you could realize a loss of some of your capital.
As with all of your investments, make sure that you understand any and all fees that financial institutions are charging before choosing where to invest. Especially in today’s low-rate environment where even small nominal fees can eat up a big chunk of returns.
And finally a world of caution on any investments being touted as “safe as cash” yet carrying higher interest rates than FDIC-insured deposits. If it seems to good to be true, or if you don’t understand what you are investing in, by all means stay away.