Motley Fool Hidden Gems Investing - Managing Cash Amid High Inflation

Episode Date: May 20, 2023

The Federal Reserve has raised interest rates 10 times since 2022. But you probably wouldn’t notice those hikes in a traditional savings account. Dylan Lewis caught up with Robert Brokamp to discuss: - How banks benefit from your inertia, and how that costs you - Ideas for managing cash for the next few weeks, months, and years - Money market funds paying more than 4%, and the caveats to understand before utilizing those accounts - Who can benefit from I Bonds and less-liquid savings vehicles Website mentioned: https://www.fool.com/the-ascent/ Host: Dylan Lewis Guest: Robert Brokamp Producer: Ricky Mulvey Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Whether or not we have a recession, to me, actually isn't important. The economy is slowing down. So it's at this time where you actually might want to keep more of your money shorter-term-ish, except that there's always the possibility that rates will go the other way, and you'll be happy that you locked up some of your money for, you know, whatever, one, two, three years. I'm Mary Long, and that's Motley Fool Senior Advisor Robert Brokamp. Dylan Lewis caught up with Bro to talk about managing cash when interest rates are high. They discuss the boring piece of financial advice that's essential for any investor to

understand, some savings vehicles that can help minimize your taxes, and how the debt ceiling debate is impacting treasury bills. We often talk about the importance of cash. It is the bedrock for your financial picture and having it on hand can turn market dips into opportunities rather than painful pinches. Today, we're talking about its importance and also how to make the most of it. I'm Dylan Lewis, and joining me to do that is The Motley Fool's resident answerer of all things personal finance, Robert Brokamp. Bro, thanks for joining me. Robert Brokamp My pleasure, Dylan. Great to see you. Dylan Lewis Yeah, great to have you in studio with me.

I think the theme of this show is going to be that the foundational guidelines when it comes to cash and how to manage it probably haven't changed very much and are going to very familiar to a lot of people. But given the environment, how and where, when it comes to cash, is probably worth considering or reconsidering for a lot of people. Yeah, and definitely this is a time when putting a little effort and thought into what to do with your cash can really pay off. Yeah, I think just given where we've been with interest rates over the last two years, a lot of assumptions that people have and I'm certainly one of those people that have had really hard-baked assumptions are

worth challenging. And it's just because what we're seeing is so different than what we've been experiencing. I'm someone who financially came of age right after the great financial crisis. Interest rates have been as low as they possibly could have been. Imagine a lot of our listeners who came of financial age around the same time feeling the same way. Right. And same with inflation, too. Inflation was so low, so you felt like, OK, I'm not getting much on my cash, but it's not really losing much to inflation. Now it's a different story, where we do have high inflation. And if you're just sitting there with your money in the bank, you are significantly losing out to inflation.

Nobody wants to be doing that. No, absolutely not. So, we're going to structure the conversation in the way that really you should be thinking about cash. We're going to build from the bottom, make sure that the foundational stuff is taken care of, and then get to some of the fun stuff and talk a little bit about maximizing what people have available. Let's start with what I think everyone knows to be the foundation here, and that's the emergency fund. Right. The most boring advice in personal finance is, accept that it's important. The classic advice is, have three to six months of must-pay expenses somewhere safe and liquid,

savings account, checking account, something like that. Even though it is the perennial advice, I would say there is a bit of timeliness to this because if you took a survey of most economists, they do expect the economy to slow down, they do expect that unemployment will go up, we might have a recession, which means the chances that you will lose your job have gone up a little bit more. this is what you need an emergency fund for, so that if you lose your job, you can still pay your bills. And the more miles you have to feed, the more obligations you have, like mortgages and car payments, the bigger your emergency fund should be.

It's the preventative maintenance that we all know we should be doing and thinking about, particularly at a time when we don't need to be thinking about doing it. Exactly. And no one likes it because you don't earn much money on cash, but you can a little bit if you put some effort. But it's like insurance. You're not buying it as an investment. Mostly, you're buying it to protect yourself. And I think that you talked about how it is the kind of boring advice that we all know or we all kind of start out with, but what's fun about the current environment is it is no longer this drag on your investment returns that I think it has been for a long time because

we are starting to see a lot of places where you can get a pretty healthy yield on money that's sitting in a savings account. Yes, but you have to put in some effort because your local bank and the big banks, they're counting on your inertia to not move your money. I'm one of those people, bro. I've banked with Bank of America for an incredibly long time. They were the first bank account. And I have to say, I think they've taken advantage of that relationship. Right. And many of the biggest banks don't need more money. They're not hungry for deposits. So, they don't have to jack up the rates they're paying because they're like, it's OK, we're happy with the money

we have already. To put some numbers to that, I think a lot of people that are with big banks and maybe haven't taken a hard look at what they're getting on their cash recently are probably seeing maybe one basis point, four basis points of interest when it comes to their savings accounts. There are a lot of places where you can be getting a lot more than that. Right. For example, The Motley Fool does have a website called The Ascent. It highlights higher-yielding checking accounts, higher-yielding savings accounts, higher-yielding CDs. Generally, you do have to be comfortable with cyber banking, some sort of online bank. There are some local banks that are also there.

But if you're willing to go with an online bank, you can get a savings account that is over 4%. You can get CDs that are almost 5%. Yeah. And depending on what measurement you're looking at, that may be something that puts you at least over the historical hurdle for inflation. Maybe not where we've been recently, but considering it is essentially risk-free return there, it's not too bad. Right, exactly. So, with the core elements of the emergency fund out of the way, that's that kind of intermediate and near-term money, how should people be thinking about that, it's probably the next

couple of years, but it's not in the next couple of months? Right. First of all, it's a bedrock of Motley Fool investing that any money you need in the next three to five years should not be in the stock market. So, that could be something like, you're going to buy a house, buy a car, send your kid to college. or you could be retired. Another bedrock for retirees is that you have what we call an income cushion. You think about how much money am I going to need over the next five years for my portfolio that should be out of the stock market, and that could be in cash. Now, it doesn't have to be all completely liquid. You could do things where you take

a little bit more risk, both in terms of where you put the money and maybe tying it up. For example, we like bank accounts and CDs because they're FDIC-insured, which is great, up to a certain limit. Maybe we'll get more into the details on that later. But if you're willing to take a little bit more risk, there's money market funds. They're not FDIC-insured, but most of them are paying almost 5% and some of them are paying over 5%. It's a little bit risky because they're not FDIC-insured. And if you look at the fine print on your money market fund, it could say something like, we can basically put a gate on redemptions during tough economic times.

So just be aware of that. And then you can also think in terms of buying individual treasuries. What I like about individual treasuries is the rates are commensurate with CDs. Treasuries are about as safe as anything that's FDIC-insured, because it's still backed by Uncle Sam. But they're free of state income taxes. And more than 40 states charge an income tax. So, it's an extra bonus. And these days, you could get anywhere between 4% and 5%, depending on the short-term treasury you're looking at. So, a lot of what you mentioned there were fairly liquid vehicles or opportunities for folks.

I know that as you start getting into things like CDs, you start to look at locking money up a little bit more. You want to talk a little bit about the mindset with what exists within some of those more liquid accounts vs. what you should be willing to be putting into things that have a six or a one-year time element to it? Yeah, so with a CD in particular, if you buy a two-year CD, the good thing is you then know exactly what you're going to earn for the next two years. That's actually a hedge against rates going down.

Maybe we'll talk about that a little later. But if you redeem it too soon, you'll pay generally a three-month interest penalty. So it is something that you have to be comfortable leaving alone. And it's great if you have a certain goal that you know you need at a certain time. Again, like you know your kid's going to college in two years. That's a good option for that. Another option for if you're willing to lock up your money a little bit are I-bonds. And I-bonds got a ton of attention over the last year because the yield was crazy high.

A year ago, they were yielding 9.6%. Virtually unheard of. Yes. Crazy, crazy. It's a little bit misleading because that's the annualized yield of what they will pay over the six months. So, no one actually got 9.6% over the year. So, it's kind of funky that way, but still very attractive. I-bonds are made up of two rates, really. There's a fixed rate and one rate that changes every six months, according to inflation.

The current yield on I-bonds is at 4.3%, which sounds bad, compared to where it was beforehand. But the fixed rate is higher. The fixed rate is 0.9%. That's the highest fixed portion since 2008. So, no matter what happens, you know that at least this money will beat inflation by almost 1%. Like Treasuries, also free of state income taxes. And you can defer the taxes, so you don't have to pay them every year, so that you only pay them when you redeem the bonds. They are not exactly liquid, though, because if you buy an I-bond, you have to leave it

alone for one year, and if you redeem it within five years, you pay a penalty of three months worth of interest. But it's great for, let's say you are within five years of retirement. You start building up your income cushion, that cash you need to spend when you retire, by buying I-bonds. very safe because they come from Uncle Sam, don't pay state income taxes, you don't have to pay the taxes each year because you can defer the taxes, you retire, you begin to redeem them, that's when you pay the taxes. But most people are at a lower tax rate when

they retire. So, you're basically doing some tax arbitrage because you have deferred at a time when you were in a higher tax rate and paying taxes at a time when you're in a lower tax rate. You mentioned that a lot of people became suddenly interested in I-bonds. I think a lot of people have probably very suddenly become interested in FDIC insurance as well, given the current state of our banking system and given what we've seen with some pretty big name banks over the last couple months. I'm curious, we think about diversification and investing in terms of owning a lot of businesses and not having a whole lot of eggs in one basket. What elements of diversification should people be thinking about

in addition to where the money is held in terms of vehicles, where money is held in terms of firms. Yeah. So, the FDIC insurance, as most people know, it's up to $250,000. And that's on, generally, checking accounts, savings accounts, CDs, and money market accounts. Now, money market funds are different. They don't have FDIC insurance. Money market accounts do. The thing is, it's $250,000 per type of account. So, you could have $250,000 in your own account, your spouse could have $250,000 in his or her account, you could have a joint account with another $250,000, and then you could have IRAs at the same bank, and as long as it's FDIC-insured investments, that's another $250,000.

You could get a lot of coverage within one bank, and FDIC actually has a great tool called the EDTool electronic deposit insurance estimator, if you want to see how much of your FDIC deposits are insured. You can get a lot as long as you arrange things correctly. But it's still important to think of diversifying your cash among banks. You don't want all your money with one bank, especially if it's a bank that might be struggling. Recently, we are paying much more attention to that type of stuff. The FDIC does a great job of taking over banks and making sure things keep running smoothly, but still, you don't want that stress in your life. And then the other part of the diversification, I would say, is doing, again, what we talked

about previously. You want to diversify. What do I need to have absolutely liquid? Something that I could spend immediately vs. money that I'm willing to tie up for a little bit longer in the hopes of getting a little bit higher interest rate. Yeah. And so the idea there is, we're not tying all of this money up on the same timeline. For folks that are generally thinking about things like bonds, there's a principle called laddering. Is it appropriate to think about it the same way? Yes, exactly. It's a little trickier nowadays because, in normal times, you go further out with a bond or a treasury or a CD, you earn a little bit more interest. Nowadays, that's

not quite the same. The sweet spot nowadays is about one year, maybe two years. But still, you could buy six months, one year, two year to get, hopefully, a little bit higher interest rate. But it does mean that you have to lock up your money a little bit. That sounds like another traditional mindset thing that people need to challenge when it comes to locking up their money and the interest rates they're going to be getting. Yeah. I mean, these are interesting times, right? You've probably all heard that the yield curve is inverted, right? You get more money nowadays from a six-month treasury than you do from a two-month treasury than you do from a 10-year treasury. That is a classic

sign of the economy is slowing down and historically a sign that we're going to have a recession at some point in the future. Whether or not we have a recession, to me, actually isn't important. The economy is slowing down. So it's at this time where you actually might want to keep more of your money shorter-termish, except that there's always the possibility that rates will go the other way, and you'll be happy that you locked up some of your money for whatever, one, two, three years. I want to talk a little bit about the macro picture, because in addition to all of the other things that people have had heightened interest in recently, a lot more people are paying attention to the Fed than

they have been over the last five years, 10 years. It's become something that conversationally pops up a lot more when you're out with friends. How are you thinking about the macro picture and just generally what we've seen with interest rates from the Federal Reserve? As you know, the Federal Reserve raised rates again at their May meeting, but clearly indicated that could have been it for this cycle. Who knows? Maybe there'll be a surprise spike in inflation. They recently had that in Europe. But most people expect inflation to keep coming down, which means the Fed has probably done hiking rates. In fact, if you look at the Fed futures market that tries to guess these things, they are betting that

the Fed is going to cut rates before the year is over. Now, the Fed has been pushing against that narrative. Various Fed officials have been out saying, do not expect that we're going to cut rates. But, to me, it seems pretty obvious that they're not going to hike rates that much anymore, which gets back to that point of, maybe you do want to use, with some of your safe money, buy some individual treasuries, individual CDs to lock in current rates because it's very possible that rates will be lower a year or so from now. It's something that I think a lot of people have to wrap their head around. We've been talking about the unprecedented times element of all the things that we're

living with, seemingly for the last three years, and we keep seeming to throw things on top of it, more things that are being challenged or being adjusted. There are so many different ways that interest rates wind up coming in and affecting the economy. I think what a lot of people are beginning to appreciate much more is the way that it comes in and affects the pocketbook. Yeah. And to add to all of that, of course, is this whole, I don't know if you can call it a debate, whatever, about the debt ceiling. That has played havoc with the short-term Treasury bill market, one, two, three months. Because people are like, I don't want to buy

a Treasury bill, which is basically lending Uncle Sam money, because I don't know if two or three months from now they're going to have this worked out and I'm going to get my money back. Longer-term, the bond market is saying, Uncle Sam's going to figure this out. But shorter-term, it's been kind of wacky. I think it's all going to work out. But I'm sure people, when they hear me say, buy T-bills, the first thing they thought is, well, who knows what's going to happen about this? That's the other thing, right? You got Janet Yellen on the news every day saying, if we don't work this out, it's going

to be a calamity. Yeah. So, to what extent do you take that stuff into account when you're thinking about cash management and just the way that you would advise people to put their money to work? Is it something that's really weighing heavily on the way that you do that? Or is it something that you kind of have to accept that there's only so much we can know about that? I say, well, first of all, I would just, again, it goes back to the diversification, right?

Any money in the bank is going to be fine. If you have a diversified bond fund, you know, maybe you'll be fine. I personally think they're going to work it out because the consequences of Congress and the president not working out will be so bad that they're not willing to do that. So they're going to keep doing this kabuki dance where they say, I want this to happen. No, I want this to happen. I'm not going to budge. Well, I'm not going to budge. and then they budge and it gets worked out. Longer term, we can't keep doing this.

I hope they figure out some way around this, because otherwise we're just going to have to keep doing this every year, every two years, every three years. We've talked about interest rates in the macro picture. We've talked about the debt ceiling. Are there any other macro factors you see playing into the way that people should be thinking about this stuff? I'll just repeat something that is really my mantra at all times, and that is, be a short-term pessimist and a long-term optimist. You don't know what's going to happen over the short-term. We don't know if we're going to have a recession. You don't even know if you're going to have a job two or

three years from now. So, you really should play it safe with the money you need in the short-term that you know you're going to need or you might need, but then invest for the long-term. Overall, we at The Motley Fool believe that the stock market is the place to be. Yeah. And it seems like, at least for the foreseeable future, you can enjoy some gains on that money that you have short-term, which is nice, and something that I think a lot of people aren't particularly used to. I'm going to put you on the spot a little bit here with a question as we're wrapping up. If someone's listening to this and they want some next steps and takeaways for applying some of the things that we've talked about

to their own financial picture, to me it seems like, check in on your accounts and just get a better sense of what you're getting in terms of interest rates from the institutions. If you see that you're someone who's getting some of those lower savings rates, what would you recommend people do? I hate to be too promoting of a Motley Fool site, but the Ascent is a great place to look for higher yielding savings accounts and CDs. If in your brokerage account, see what money market funds are available. This is another thing that brokerages do, they keep money in cash that just sits there. It might be in a sweep account, it might be just

regular cash, but you're probably earning virtually nothing on that. So, you think about, OK, how much really liquid cash do I need? And then look for higher yielding opportunities. And the most important thing, I really think, is to evaluate how much cash you need. Look out over the next three to five years and think, OK, how much am I going to need? Is there any big expense coming? And then rearrange your portfolio so you are protecting the money that you think you may or you definitely know you're going to need in the next few years. Yeah.

All of the compounding happens with money that's in the market, because it's not being touched, it's being left alone. Exactly. Well, Robert Brokamp, thank you so much for talking to us. Great. It's been a pleasure to be here. As always, people on the program may have interests in the stocks they talk about. and The Motley Fool may have formal recommendations for or against, so don't buy stocks based solely

on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.