The Best Places to Put Your Cash

The Federal Reserve increased interest rates to 4.6% in February 2023. What does this mean to you?

It means you can earn ~4.6% per year (pre-tax) by putting your cash in the right places. In other words, $100,000 of cash would produce roughly $4,600 in annual income.

We’ve outlined some of the ways you can earn yield on your cash.

Below are three options:

• Directly invest in the short-term debt of the U.S. government, corporations, states, and municipalities.

• Put cash in money market funds invested in short-term debt from the U.S. government, corporations, states, and municipalities.

• Earn interest in either checking or savings accounts at a financial institution.

Direct Investing - U.S. Government, Municipal, Corporate Debt

You can directly purchase short-term U.S. federal, state, local municipal debt, or corporate debt and obtain a yield on your cash. The direct investing approach has the potential for the highest returns because there are no fees paid to a money manager.

The downside to directly purchasing debt securities is that it requires time and expertise. One needs to select appropriate securities, and reinvest proceeds from interest payments, and principal repayments, into new securities.

Directly purchasing U.S. Government debt offers certain benefits:

• Credit Risk - U.S. federal debt is considered the safest investment for U.S. residents and is backed by the full faith and credit of the U.S. government. This debt is often referred to as risk-free by financial professionals.

• Taxes - Income earned from treasury bill securities is exempt from state income tax.

Directly purchasing state or municipal debt embodies a slightly different risk profile:

• Credit Risk - We consider this form of yield to be slightly riskier than U.S. federal debt. Default rates have been very low for highly rated state and municipal issuers, so it is still reasonable, in our view, to consider this debt to be a “cash equivalent.”

• Taxes - State and municipal debt can be highly tax efficient for investors who invest in bonds that match their state of residence. The interest from this debt can be exempt from federal, state, and local income taxes. As a result of this tax shield, the headline yield of municipal debt is often lower than that of U.S. federal debt, though the after-tax yield may be similar.

Purchasing corporate debt, which we believe is the riskiest option:

• Credit Risk - Corporate debt has been riskier than government (federal, state and municipal) debt.  We believe that corporate debt is not safe enough to be considered a cash equivalent even for highly rated companies.

• Taxes - Unfortunately, interest earned on corporate debt is tax inefficient because it is taxed at the state and federal level.

If you have the skill, experience, and time, we believe that direct investing in federal and municipal short-term debt will likely lead to the highest returns on your cash. 

Money Market Funds

We believe investing in money market funds is a simpler way to earn yield on your cash, and many charge low fees. A manager takes care of selecting securities and reinvesting proceeds, while most money market funds offer liquidity in one business day, should you need the cash. 

There are nuances among funds that may make it difficult to determine which one is right for you.

For example, we recently analyzed which money market fund would be best for a NJ resident who pays the highest marginal tax rates at the state (10.7%) and federal (37%) level.

Below are four potential investment options:

The NJ residents earn the highest after-tax yield (2.8%) by investing in GABXX, a U.S. federal government focused money market fund.

Notice that GABXX’s 7-day yield of 4.4% is lower than that of SNAXX 4.6%. However, GABXX's after-tax yield of 2.8% is higher than that of SNAXX’s of 2.4%. This is due to more tax efficient holdings.

• Of the four options, FZFXX and GABXX should be the safest with their underlying investments in U.S. federal government debt.

• GABXX is more tax efficient than FZFXX. It holds a larger concentration of U.S. federal government securities directly rather than through repurchase agreements.   

• GABXX has a higher 7-day yield than FZFXX due to lower management fees.

• FSJXX is the most tax efficient with an effective income tax rate of 2%, though its after-tax yield is the lowest amongst the four.

• SNAXX is the riskiest and the most tax inefficient. We would not recommend investing in this money market due to its exposure to corporate bonds.

  Note: A money market fund’s after-tax & fee return is influenced by an investor’s marginal tax rate, state of residence, and underlying holdings of a money market fund.

Checking & Saving Accounts

Probably the worst way to earn yield on cash is through a bank checking and savings account.  

The average yield earned on savings bank account cash is 0.35% as of February 2023. This is a much lower yield than the 4.6% we discuss above and it’s largely because many banks are able to get away with paying very little interest to their depositors, due to features they offer, like direct deposit, that make deposits sticky. We have advised clients with low-interest bank accounts to limit their balances at those financial institutions, and to shift more cash into appropriate money markets.

• Credit Risk - Bank deposits have a low risk profile since banks are FDIC insured and protect customer deposits up to a certain threshold ($250K for an individual and $500K for a joint account). Deposits above these thresholds are imprudent because of the reliance on the credit worthiness of the bank, which places those balances at risk. 

• Taxes - Interest earned on your bank accounts is tax inefficient, as you are taxed based on your ordinary income tax rate at the federal and state levels. This rate can reach or surpass 50% for high income earners.