Cash Management is back on our radar, and it should be on yours too. Remember the forgotten term “compound interest” you used to hear about? Well, that’s back too. Compound interest is the money you earn on both your principal and the interest you have already earned on that principal. Yes, you probably already knew that, but it is worth a refresher since it has been a while since it mattered.
3% interest on $10,000 yields $300 in additional savings. When reinvested, you will earn 3% interest on $10,300, or $309 the following year, and so on.
Compound interest is so impactful that even Albert Einstein once said, “(it) is the eighth wonder of the world. He who understands it earns it: he who doesn’t pays it.” He was an intelligent fellow.
In the past few years, prioritizing where you hold your cash savings fell to the bottom of the list since interest rates were at historic lows. It was not worth the time spent scouring the internet looking for which financial institutions paid the highest rate when the choices range from 0% or .05%. Compounding pennies isn’t that inspiring. But as my daughter used to say, “that was soo last year.” As we all know, 2022 is different. The economic landscape has changed significantly. And interest rates for cash deposits are on the move higher.
But the kicker is: Not all savings and financial institutions are passing this increase in savings rates on to you. So, you must be aware.
The Federal Open Market Committee (FOMC) has increased its benchmark interest rate four times this year for a total of 2.5% percentage points. At its July and August meetings, the rate increased by 75 basis points, the two largest single rate increases in over 25 years. They will meet again this month and are expected to increase rates again by another 50-75 basis points.
If you are like most people, then you just assume that your bank savings account was increasing in lockstep with rates. Have you checked out your interest rate on your bank statement lately?
You might be surprised to learn that your bank only pays around .05% interest on savings still.
Most larger banks are not passing the higher interest rates on to your savings accounts. They are essentially keeping the spread for themselves. And on top of that, they are charging you higher interest rates to borrow. Good for bank profits. Not good for you.
Why aren’t they passing along the higher rates? Because they really don’t need additional deposits or want to attract additional deposits. They have plenty. According to CNBC, “Back in 2020, the U.S. unleashed hundreds of billions of dollars in stimulus to small businesses and families, propped up markets with bond-buying programs, and took rates to near zero. Much of that cash found its way to banks, which soaked up roughly $5 trillion in new deposits in the past two years, according to Federal Deposit Insurance Corporation data.”
Bottom line: Manage your cash by finding the best place to earn a rate that is closer to the federal funds rate. Look to online banking institutions and money market funds. For example, Charles Schwab has multiple money market funds paying around 2% that should increase immediately if the FOMC raises interest rates again in the next couple of weeks. There are also plenty of options elsewhere to choose from if you look.
If you are a client of Ranch Capital Advisors, as a courtesy, we are offering our clients the ability to utilize Schwab’s money markets and exclude it from any advisory fees. Because keeping cash in the banks is a real opportunity cost that none of us can afford these days. If you would like to find out more, please reach out.