Best Way to Maintain Your Immediate Cash Reserve

Summary: Maintaining your cash reserve, typically six months of income, in an online bank’s savings account will allow you to earn the highest rate of return on those funds while maintaining ready access to the funds without market risk exposure. An account with Treasury Direct is another option for some of the funds that don’t have to be immediately available. End Summary.

A client, a federal government employee, asked for advice on how to maintain her cash reserve and it makes sense to summarize that in a blog post. First, let’s review the basics.

The rule of thumb is to maintain six months worth of income readily available in order to weather things like job losses, vehicle emergencies, and other similar contingencies.  It’s important to do this in order to avoid taking on debt during these situations or to have to liquidate investments during a down market in order to meet these requirements.  Saving in such a fund, even while in debt, is an important component of debt reduction because without it, it can seem impossible to break the debt cycle given life’s financial uncertainties. A good strategy is to contribute an amount to the fund each paycheck while servicing one’s debt or even paying down the principal, albeit at a slower rate given the savings buildup. Okay, that said for context, here’s the main issue.

Most financial institutions are paying less than a half percent interest on deposit balances. Inflation is in the two percent range so that money is actually losing value. The good news is that there are other options. Here comes online banking to the rescue. A quick search on “online banking interest rates” will bring up several quick comparison sites. We, as always, strive to save you time. Our pick:  Goldman Sach’s Online Savings Account.  The account has no minimum balance, can be opened fairly easily online, and is currently paying 2.25 percent APY interest compounding daily. That’s a winner. That said, there are several similar offerings, so feel free to shop around.

Another option for balances that don’t need to be immediately available and yet for which you don’t want market risk exposure, is the U.S. government’s Treasury Direct.  Through an account there you can invest directly in short-term bills and bonds with various time horizons. We use this, as do several clients, and find it an easy way to eak out a bit more interest.

Drop us a line if you have questions or send a message at the firm’s facebook page.

To Buy or Not to Buy a New Car?

The genesis of this article was a brief conversation in which a colleague was justifying the purchase of a new car. Now, he already has a car, it’s not the car he’d buy today, and he’s still making payments on it. Recently, the air conditioner stopped working and he’s not yet troubleshot the problem. It could be the compressor, the clutch (something as simple as a fuse), a problem with the expansion valve or other evaporator problem. It could have a leak that allowed all the refrigerant to leak out. In any case, this problem is being used to justify taking on additional debt to get a more expensive, larger vehicle. He also wants an electric car, an issue that we’ll set aside for a later post.

The real issue, though, isn’t the pending repair bill. It’s the masking of a debt-financed consumption desire by the repair bill. This makes me think of an analysis I conducted years ago when faced with a similar decision.

Back then, I got a second job on the other side of town, almost an hour away by freeway driving time. I was driving a ten-year-old car at the time and it didn’t get the best mileage. The thought occurred to me that I might be able to get a new car and actually save money based on the increased fuel efficiency. But, before I jumped into a new car, and commensurately, a new car loan, I wanted to confirm the numbers. To my surprise and disappointment, the numbers just didn’t work out. Gas would have had to have gotten up above $5.00/gallon to make my decision work financially. So, with that off the table, I was reduced to considering a consumption rather than a financial decision.

As with any consumption decision, the issue is this: What do I want to give up to consume X [insert whatever you’re thinking of buying at the X]? Now, given my framework, I value consuming financial stability above everything except a place to live, necessary clothing, and food. Following stability is financial well-being and a long, relaxed, partial-retirement (what’s come to look like the “gig economy” except I can work when I want to and play when I don’t want to work). After that, my framework allows for entertainment, social considerations, and outright consumption like adult toys (all that sporting hobby equipment, not what you were thinking!).

Where did a new car come out then? It didn’t. I continued to drive the old car until it’s engine head warped (it was aluminum) and even then, I looked closely at dropping a new one onto the engine. One of our saving funds was new car purchases so we also shopped for a small subcompact and found a good deal for a Nissan Sentra, 5 speed, bottom-grade trim car. We were then off and running for another ten+ years. We sold that car overseas when we’d had it for 12 years.

Transportation purchases are one of the most common wealth-draining purchases people make. At this point, I’ve heard almost every rationalization known, and they are all just excuses. The real issue is to learn to manage wants versus needs. Conflating the two is what holds most people back from financial well-being. The tool to avoid this: Having a financial framework that allows you to produce a budget and stick with it. The framework will allow you to have a ready reference to how you prioritize what you do with your financial resources today and tomorrow.

There’s also a maxim at play here. “Don’t let a bad decision cause you to make more bad decisions.” Say, for example, you don’t like the car you bought. Perhaps you deem it to be unreliable. To come to terms with a reasonable decision, given your financial framework (or philosophy some call it), run the numbers, throw in some probabilities, assess the ranges, figure out what you have to give up (all the other possibilities for those dollars) and then make your decision. In this case, there’s likely little way that the most expensive air conditioning repair will justify driving another car off the lot.

The money you save by controlling consumption impulses will allow you to focus on building wealth. Financial freedom and non-working retirement years require income streams. Only productive capital can produce those streams. Every time we buy something that isn’t productive, we’ve taken a step back from financial freedom.

While this is not a financial lifestyle blog, the reality is that you do have to save money in order for us to help you build tax-advantaged wealth. Once you are accumulating savings, don’t forget to have a chat with us about where you are, financially, and where you want to be.