What to Do with Cash in the Bank: Fundamentals of Investing

Hello and welcome again to our Fundamentals of Investing series. These videos are designed to explain important concepts you need to know as you work to secure your retirement and build your personal wealth. I'm Brian Dress, Director of Research here at Left Brain, joined as always by our CEO and Chief Investment Officer, Nolan Langford. Nolan, thanks for joining us.

Thank you, Brian. Glad to be here talking about this important topic.

Thank you, Nolan. In these videos, we want to answer the questions we hear from investors, both clients and others that we speak with. As interest rates were so low for so long, investors were spooked by the way markets moved in 2022. Many of them have let cash accumulate at the bank. So today we're going to cover what to do with cash in the bank. So, Nolan, first question for me is, can you describe what has changed in the economic environment and why investors may want to consider doing something else with the money that is building up in their checking and savings accounts?

That's a really good lead-in, Brian. The world has changed here in the last few years and certainly in the last few months. One, we have interest rates that are on the move and we lament the fact that when we go to the grocery store or the gas station, things are higher. But in order to tame inflation, interest rates have definitely increased and they've increased pretty dramatically. On the borrowing side, if you think about mortgage rates, they're doubled over the last 12 months. But interest rates are higher across the board, and that means our savings accounts that we have at the local bank are paying more. All the lending products are paying more as well. And so we need to take a look at all of our holdings. And with cash paying more and interest rates being up, and we need to take a look at our finances through that lens.

Okay, Nolan, that's a good lead-in to what we're going to discuss here. There are a number of ways we can put cash to work. I know I can think of a number of extravagant ways to spend money, but we're going to talk a little bit more prudently here for people who are trying to save and put their retirement together and secure their financial goals. So let's talk through some of these good uses of cash. The first one we're going to talk about is paying off credit card debt. So, Nolan, the other side of that coin you were talking about, interest rates are up. That's good for savers, but it's also really bad for people who are in debt. If you've got credit card debt, of course, credit card rates have gone higher, and that really makes it a lot more important and imperative to get that credit card debt paid down. Nolan, can you talk about why this is really what we call the number one main priority for people when they have cash, is to pay down credit card debt? Why is that?

So unlike some other debt like mortgage debt, which is fixed, credit card debt floats. And so that rate changes constantly, and it's a rate set by the credit card or the bank It's based off of what we could call the prime rate here in the US, plus the lending institution will add a spread. So as that interest rate goes up, the base rate or the prime rate goes up, the total amount of interest paid goes up. And as everybody that's listening should be aware, rates have gone up pretty dramatically in this country. That prime rate, to a large extent, is based off of federal rates, but they directionally, they move the same way. Short-term rates from the government has gone from 0 to 5%. Think about that. Base lending rate has gone up just as dramatically. So if you have a credit card outstanding, it's very likely that your interest rate is well into the double digits. That's something that, that most investors really will want to take care of.

So, Nolan, we want to get rid of credit card debt first. We've said this for years, but it really is more imperative this year. With the higher interest rates. So once that credit card debt is all handled, we're going to talk about the second topic that we want to discuss here, which is the emergency funds. Nolan, can you talk about the importance of an emergency fund? And then also, of course, if people agree that, that they need to have an emergency fund, how large does that emergency fund need to be before they start committing other funds to investing?

Yeah, so depending on each person's circumstances and what they have going on in their, their life, if they're you know, married, raising kids, what their cash flows are, if they're out of work, working, that differs. But the broad range is 3 to 6 months. We want liquid reserves on hand, something I can get to quickly within a day or two. For most people, it's going to be the local bank and a checking account, money market or savings or passbook savings account. And we generally say 3 to 6 months. Of your expenses or living expenses, not extraordinary items like travel or home repairs, but just your normal bill flow on a monthly basis. 3 to 6 months is what we want to have in reserve. Excellent.

Very important to have that on hand if something happens from a medical point of view, from an employment point of view. There's plenty of things that can happen that we want to make sure that investors have that liquid cash on hand just to make sure they can cover their expenses. We've gotten that out of the way. Credit cards, we've gotten the emergency fund out of the way. So this leads more into what we do. That's investing. The third is retirement accounts. Nolan, so what is the order of operations for investors looking to contribute funds to their retirement vehicles? What should they fill first and what are the yearly limits for them to do so?

The big one for most investors is going to be the 401(k) account. That's the individual's version of a retirement account. Most Employees in this country will not have— no longer have pensions where the employer was responsible for your retirement income. Now the onus is on us, and we have these DIY, yeah, do-it-yourself accounts. 401(k) is part of that mix. So we put in and contribute money to the account. It grows tax-deferred. As an incentive, our employer will match us up to a certain percentage of our salary. We can put that money in investments, and depending on how those investments do, that'll determine the rate of return in this portfolio. Because of this, there's two big incentives that we have here. Well, really three. One is we want to put money away today while we're working so later on when we're no longer working, we can draw off those funds and replace our income that we need to live on. That's a big incentive to do. The other one is the government gives us incentive in the form of tax deferral. So it doesn't cost us $2, $1 to save $1. Any money that I put in is not taxed to me today. So as an example, if I make $100,000, I put in $10,000 into my company retirement plan pre-tax. I'm taxed on my W-2 or my 1040 as if I made $90,000. So that $10,000 comes off the top pre-tax. That's incentive number 2. The third incentive comes from my employer. For every dollar I put in the plan, if an employer has a match, he'll match that money up to a certain percent. Each employer can determine which formula that they use, but there generally is going to be an incentive. So that's like free money on top of the deferral that I'm getting from taxes. So it's really a good deal for savers.

Yes, Nolan, we want to definitely emphasize we want to get the employer-employee match. So make sure you definitely contribute enough to the 401(k) to get that match. And then there's also options as well. If you fill up your 401(k), there's IRAs, there's Roth IRAs. These are all retirement accounts that you should consider and speak to a professional about which are the best for you. And, and then, Nolan, this is our favorite category, the Beyond category. You've got your credit card debt, you've got your emergency fund, you've saved all your money you can in retirement accounts. Then there's a fourth category that's beyond. So, Nolan, if people at home have been diligent, done all the first three, What should they do next with cash in the bank? I think this is the question we get the most because money is starting to pile up over the last couple of years for folks. Are there certain types of investments that generate return with limited risk? Can you give us a little commentary on what is the kind of the best way to approach savings beyond your retirement accounts?

Yeah, I think you're hitting all of these in really good succession. We do want to pay off our credit card debt. We don't want to owe anybody except for our mortgage, so we want to pay that off. We want our emergency fund of 3 to 6 months, and then we definitely want to make sure we're funding our retirement accounts, 401(k)s, SIMPLE plans, what have you. But then above and beyond that, if we have any excess money that we need to save, the question is, how do we do it and what's the sort of investment security in order to do that? So, if you have cash, which is liquid, it's a really safe investment and it's liquid. Let's call that a sort of a level zero on the risk scale asset. And if you step away from that, your risk level is going up somewhat, but we should also expect our return to go up somewhat. If I'm at a level 0 and my bank is paying me 4% or something on my money, I may not want to go way out on the, uh, on the risk scale to stocks, which move around daily and don't necessarily pay a consistent income. But there are things that you can do in the middle. And some of those things that we like to talk about are tax-free bonds, which are called municipal bonds. There's CDs, which is certificates of deposit, where we can tie our capital up with the bank at a little bit longer and get a little bit higher interest rate. There are corporate bonds that you can purchase where corporations will pay you a fixed rate of return. And so these are all things that you can do above and beyond just having your money at a local passbook. Account at the bank or a savings account. You can step out a little bit, take a little bit more risk, but you can get some fixed rates of return. And now that rates are higher, a lot of these securities pay very interesting rates of return— 6%, 7%, 8%, and in some cases 9%. Excellent.

And we just want to remind everyone, we do have a huge list of bonds, of corporate bonds and other bonds that we have been recommending for clients. We'd love to talk to you and discuss whether they make sense for your circumstances. I'm going to ask you one last question, Nolan, as a bonus. You did bring something up, question that does come up often when people have excess cash, and that's mortgages. A lot of people obviously own homes, they have mortgages on their homes, some of which are at really attractive rates, you know, 2, 3, 4, 4%. Obviously a lot of people don't want to be in debt. They, they wonder, should I just pay off my mortgage? Can you talk about the pros and cons of just paying off the mortgage with cash that you've got in the bank?

This is a really important question. It's a serious question, and I know particularly for retirees or people as they just retire or getting ready to cross the finish line for retirement, it's the number one topic that comes up. I have this outstanding mortgage. They've always heard all their life, pay off your home, pay off your home, and now they want to know, is this a really good idea to take my liquid cash, which is liquid, and put it into my home which is illiquid. Does it make sense? And for each person, it's going to be different. We encourage all the viewers to sit down and talk to your financial professional and take a look at your individual situation. You want to take a look at your financial model, your liquidity needs, any upcoming big expenses, and see if it's right for you. Certainly, if you're one of our clients or you don't have an advisor, we're happy to have that discussion with you. One of the things that we think about is the interest rate that you're paying on your mortgage. Now mortgage rates are higher, and I'm going to venture to say for everybody listening to this video as of today, February 23rd, 2023, just about everybody listening has a mortgage rate on the books that's lower than interest rates are currently. So it's not as easy decision as you may think. You may currently, if you were buying a home today, maybe you would go out and pay 5.75% or something on a, on an interest rate. And if you did that, depending on your tax bracket, 22% or something tax bracket, your after-tax cost to borrow that money is probably somewhere around 4.5%. And so the question is, one of the questions is, can I get more than 4.5% after tax in some other security? And now with fixed-rate securities, you certainly can build a portfolio and get over 4.5%. That's not the only question or the only variable you need to look at, but it's one of them. Gets a little bit more difficult with people with loans on the books much lower. You know, some of our clients have interest rates at 3%. And again, if you're in the 22% tax bracket, your cost to borrow that money's, you know, 2.3% or somewhere in that neighborhood. And the question is, should I take my liquid cash, tie it up in my home, which is illiquid, and earn 2.3% after tax? Or can I go out and get another fixed-rate securities that may pay me 4 or 5 or 6? So it still may make sense, but it's not the slam dunk you think, which is why we suggest you talk to your financial professional, look at your financial model and, and make a right and make a decision.

Thank you for that. I know a lot of people are wondering. It's definitely a question we hear all the time. So in terms of uses of cash, it's great if you've got cash building up in the bank. That's a high-class problem. Again, just to review, you know, the first priority has got to be paying off credit card debt. Second is make sure you have that emergency fund. Third is make sure you fill up that retirement account. And then from there, plenty of different ways to invest the money and gain a return. So, Nolan, thank you for being with us. We want to thank the viewers. And any last thoughts as we close out the video?

Nolan? Yeah, I just wanted to say, you know, earlier we were talking about rates for 401(k)s, for IRAs, and I just wanted to remind the viewers the limit changes every year. For 2023, the contribution limit as an employee is $22,500. And if you're like me where you're lucky enough to be 50 or over, there is a catch-up provision at $7,500 per year. So if you're 50 or older, you can actually contribute $30,000 per year to your employer 401(k) or 403(b) or 457 plan. And then for everybody else saving money into an IRA, the contribution limits this year are $6,500. It's both for Roth and the traditional IRAs. And then there is a catch-up provision. It's still $1,000 in IRAs. So the total contribution limit 7500.

It's all really helpful information, Nolan. Cash in the bank. If you got any questions, we're happy to answer them. We hope this was informative and catch us again on the next Fundamentals of Investing. Bye now.