Don't Make These 2 Mistakes With Your Cash On Hand
It is hard to stay on top of your personal investments when you are a business owner. Growing your business or your new venture is your number-one priority. Sitting down and making investment decisions for your own money often gets pushed wayside.
One thing you can do right now to improve your investment situation is make sure you’re not making two very common mistakes with any cash you have on hand. Maybe you need this cash to re-invest in your business? Or maybe it’s there to pay off some debt in the near-term? Regardless, optimizing where your cash is stashed is an easy fix that a lot of entrepreneurs overlook.
Mistake #1: Leaving cash in your savings account at your local bank.
Why? The interest rate you’re paid per year on money you have sitting at your bank is most likely around 0.05 percent to 0.10 percent on a good day. Even when we take into consideration the slight increase in interest rates lately, interest rates are still very low across the board.
The Fix: “Online” high interest (or high-yield) savings accounts offer you up to 10x the interest rate that brick-and-mortar banks offer. They can offer higher interest rates to their clients because they have much lower overhead, primarily because they do not have thousands of branches they need to support. Online high-interest banks can pass on that cost savings to us in the form of higher interest payments.
For example, Discover Online offers an annual yield of 0.90 percent while the national average yield is 0.08 percent. While 0.90 percent still seems low, online high-interest banks offer significantly better interest rates on your cash than your local brick-and-mortar bank and you will see the interest payments add up over time, especially as interest rates increase back to normal levels.
Related: Is Life Insurance a Good Investment?
Mistake #2: Investing in a “short-term” bond fund thinking your money is in “cash.”
Why?: When you invest in a short-term bond fund, that fund takes your money and invests in securities (mostly short-term bonds) that have high liquidity. Meaning, they’re easily bought and sold. But here’s the problem: most people think their money is sitting in cash when they are invested in a short-term bond fund, risk free, but it’s not.
The short-term bond fund invests your money in short-term securities that offer you a higher yield than your cash sitting at your local bank. That’s great. The problem is, when advisors recommend short-term bond funds as a place to “park your cash,” they often forget to tell you that your money is now susceptible to interest-rate risk.
Bonds lose value when interest rates increase. Why? Because you own an older bond that now pays you a lower interest rate. The bond you own is now worth less since it pays you the old lower interest rate. That is called interest rate risk. The Fed is expected to potentially increase the federal funds rate at the end of this year. On one hand this is good because you will eventually see an increase in the yield you receive on money you have sitting in cash. On the other hand, this increase in short-term interest rates will cause short-term bonds to lose value.
A huge misconception people have is that short-term bond funds = money sitting in cash. That is 100 percent not true. You are invested in short-term bonds that will lose value as interest rates increase. That is interest rate risk.
The Fix: Similar to the above, a high interest account is a good way to maximize interest you receive without having to take “interest rate risk” associated with investing in a bond fund.
The bottom line is you’re busy running a business and have very little time to manage your investments. Two simple things you can do to make sure you’re maximizing the cash you have on hand is explore a high interest online savings account and make sure you understand the risks involved with your short-term bond fund investments.