How to Make a Little More Money on Your Excess Cash (with a Bit of Work on Your Part)

With short-term interest rates at very low levels, many are wondering if there is any way to earn a higher return on their cash balances. We generally recommend that clients maintain an emergency reserve of 3-12 months worth of after-tax living expenses. The specific amount varies by client and depends on several factors, such as the level and predictability of your income as well as your personal preference. Many clients choose to meet their liquidity needs by keeping a home equity line of credit available, and keeping their cash invested with a long-term focus at their desired asset allocation.

This article will focus on how to get a little more yield on an existing cash balance.

Currently, money market rates are almost zero and certificate of deposit (CD) rate are low as well. One currently attractive investment to consider for small cash balances are Series I Savings Bonds issued by the U.S. Government, which are currently earning an annual rate of 7.12% for the next 6 months. How can this be, you ask? It has to do with the way the inflation adjustment is calculated, and you would be taking advantage of the currently high inflation readings we’ve been seeing in the economy. These securities have some other interesting characteristics in favor of you as the buyer, which is unusual in the investment universe. Here’s how they work:

The earnings rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the life of the bond, and the semi-annual inflation rate (think “I” as in “inflation”). The 7.12% composite earnings rate for all I Bonds purchased through April 30, 2022, will apply for their first six months after issue. The earnings rate combines a 0% fixed rate of return with the semi-annual 3.56% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U). The inflation rate changes every 6 months, so your earnings will fluctuate with inflation.

The bonds cannot be redeemed for 12 months after issuance, and there is a penalty of 3 months’ interest if they are redeemed before 5 years. Purchases are limited to $10,000 per Social Security Number, so a couple could purchase up to $20,000 annually. Natural persons only, sorry no businesses (although some trusts and estates are eligible purchasers). You can make purchases directly at www.treasurydirect.gov and manage this process from the comfort of your couch by opening an account there and linking your current bank account.

So why would you want to invest a portion of your liquid cash in something that carries a penalty for 5 years?

Because if you act by April 30, you are in effect creating a 1-year CD with a yield of at least 3.56%. For the next six months, I Bonds will earn interest at an annual rate of 7.12%. The inflation rate will then reset. Since the current fixed rate is zero for the life of the bond, the earnings rate for the next 6 months will just be the inflation rate. If the semi-annual inflation rate stays the same at 3.56%, the earnings rate for the next 6 months will also be an annual rate of 7.12%. Even if the inflation for the second 6 months goes all the way down to zero (unlikely), you would earn a return of 3.56% over the next year versus 0.40% in a bank CD.

What if there is an emergency and you need the money? You cannot redeem the bonds for 12 months, so you need to leave some liquid cash on hand. After 12 months, just pay the penalty and you are still way ahead of where you would have been in a bank CD. The Treasury will credit your bank account in a day or two after redemption.

You can either buy the full $10,000 per Social Security Number all at once, or just repeat this process periodically to create a ladder of bonds maturing at different points, say every 3-6 months.

Some other benefits of I Bonds include:

  • Interest is exempt from state income tax
  • If you buy the bonds on the last day of the month, you still get interest for the full month (I call this the Mendelshon option after the man who taught it to me many years ago, I couldn’t believe what he was saying but it turned out he was right)
  • You don’t have to worry about FDIC insurance or shopping around to different banks for the best rate. I Bonds are direct obligations of the government, whereas FDIC insurance is a fund consisting of a small percentage of deposits that are covered
  • The interest rate can’t go negative if there’s deflation (everybody’s worried about inflation now, but you never know)
  • There’s no price volatility like you would have if you bought an inflation-protected bond (TIPS).
  • If the fixed rate increases significantly at some point in the future, just redeem some of your existing I Bonds (the penalty, if the redemption is within the first 5 years, will just be deducted from the proceeds that TreasuryDirect credits to your bank account). Then turn around and buy some new bonds with the higher fixed rate (but remember the $10,000 annual limit on purchases for each Social Security Number).

Sounds complicated, but it’s really not!

Bill Hansen, CFA
President & Chief Investment Officer

The views expressed are those of the author as of the date noted, are subject to change based on market and other various conditions. Material discussed is meant to provide general information and it is not to be construed as specific investment, tax or legal advice. Keep in mind that current and historical facts may not be indicative of future results. Certain risks exist with any type of investment and should be considered carefully before making any investment decisions.

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