How To Put Your Lazy Cash To Work For You

It’s official. The United States hit a record savings rate of 33% in April. This was due in part to the coronavirus shutdown ... along with billions of stimulus dollars dished out by the government.

This is great news!

A high savings rate means more Americans are on the path to financial freedom or, at least, financial security. So what’s the best way to handle these extra savings?

Putting money to good use really comes down to mindset. Think of each dollar as an “employee” ready to go to work for you. If you were running a small company, you’d make sure you were getting peak output from your employees.

So put on your boss hat and get to work directing those dollars! You don’t want your savings eating donuts lazily in the breakroom. Do you?

Prep for the unexpected with an emergency fund

I’m often shocked by how much “lazy” cash a person will hold. Often, it’s because he or she claims to be waiting for the right time to invest. Since not even financial wiz Warren Buffett knows how to time the market reliably, it’s pretty safe to assume you don’t either. With that in mind, a good principle is to invest when you have extra money to invest.

So how do you know if you have enough extra cash to do that? Start by setting aside enough to cover 1-2 months of your household spending needs.

Once you’ve settled on a reasonable stash to cover bills, you can move on to the next step: establishing your official emergency fund. This is an account full of money to help you through a job layoff or major unexpected expense, like a car accident or home repair.

An emergency fund should cover 3-6 months of your spending needs if you’re currently working. If you’re retired, it should include about one year of spending coverage.

Hold this emergency fund in the highest interest bearing, FDIC insured account you can find. For help with this, search websites like www.bankrate/banking. Or you can consult directly with your brokerage account advisor.

In the current interest rate environment, you can expect about 1% on 6-month CDs and 1.35% on money market accounts that are FDIC insured up to $250,000. This paltry rate of 1-1.5% isn’t much, but the return is backed by government insurance. This means your emergency fund interest rate is basically guaranteed.

Eight money-making ideas for building wealth

Once you’ve set aside your emergency fund, move the rest of your excess cash to one of the options below. These “hard-working dollar” ideas allow you to earn returns by investing your money, avoiding interest payments on debt, and/or earning return from an employer match or IRS tax break. Generally, these ideas are in order of priority:

1.       Get the 401(k) employer match - Approximate return opportunity: 69%

If your company offers a 401(k) match, contribute up to that point. This allows you to earn return from the employer, which is typically 50%. You’ll also receive investment return by putting money in low-cost index funds. These may include target date funds, if available, at a rate of about 6-8% per year over time. You may get an additional 10-15% return based on the difference in your marginal tax bracket between now and retirement, but best to confirm this with your tax professional.

2.       Open a Health Savings Accounts - Approximate return opportunity: 38%

If you’re in an HSA-eligible medical plan, contribute up to the limit ($7,100 for families and $3,550 for individuals). This results in a tax break at your marginal rate going in (up to 25-35%). It’s also tax-free coming out if used for medical expenses. In addition, these dollars can earn return in mutual fund investments, giving you another 6-8%.

3.       Pay off credit card debt - Approximate return opportunity: 12-22% (depends on interest rate)

Most credit cards charge interest at a rate of 12-22%. Paying off this debt automatically delivers you a double digit return. Most individuals should ALWAYS pay off their credit cards, preventing debt in the first place. Think of it this way: Any recurring balance is like a small fire burning down your financial house. Put it out as quickly as you can.

4.       Exceed the 401(k) match limit - Approximate return opportunity: 19%

If you’re already getting the 401(k) employer match, consider investing up to the maximum limit ($19,500 in 2020 if under age 50, and $26,000 if over age 50). By going beyond the match savings described in #1 above, you’ll get an additional tax break now. If you’re in your low earning years (annual income of less than $40,000 for individuals and $80,000 for families), you might opt for a Roth 401(k) or Roth IRA instead.

5.       Pay off additional debt - Approximate return opportunity: 6% (depends on interest rate)

Do you have outstanding college loans, helocs or car loans with an interest rate of 6% or more? Pay them off and recoup the money that would have gone toward the loan interest.

6.       Invest in a college savings plan - Approximate return opportunity: 6-8%

If you’ve got kids or grandkids heading to college in the future, put funds in a 529 plan that grows tax-free. The plans offered by Utah and Virginia are worth a look. They consistently rank in the top five, based on Morningstar’s annual review of the country’s top 529 plans. Be sure to check your state’s plan too. You may be able to get state tax deductions. Important note: Grandparents should NOT open these plans in their own name. It could lower the amount of financial aid their grandchild receives. (Contact me to learn more.)

7.       Invest in a taxable investment brokerage account - Approximate return opportunity: 5-7%

Planning to make a large purchase far into the future? Perhaps you’re saving up for a new car or house. Or maybe you want another way to increase your retirement fund. Putting money into this type of account can help your money grow on autopilot. That way you’ll have the cash you need when it’s time to pay for that big item. Err on the side of conservative investment allocations, depending on your timeframe.

8.       Pay down part of your home loan - Approximate return opportunity: 3-5% (depends on interest rate)

If you’ve got cash to spare, consider paying down your mortgage. It’s an easy way to get an instant return equal to your interest rate. Keep in mind this is minus the tax benefit if you’re itemizing deductions.

Time in the market matters most

When you put your money to work using one or more of the options above, you’re setting yourself up to grow more wealth. You’ll also be ahead of many others who hoard their cash, waiting for the perfect time to invest.

People who wait act as if a beacon from outer space is going to come down and alert them when to act. Something that top investors insist is very unlikely to go well most of the time.

What matters most in the world of investing is time IN the market. Not timing the market, despite what the TV commentators push on their daily shows. If you follow the ideas I’ve mentioned and sensibly direct your dollars, you’ll earn returns ranging from 3-69%.

An average return of about 7% will set you on a path to doubling the dollars you save every 10 years. This is how you can take a mere $10,000 saved per year, and build it to $20,000 10 years later.

Over time it will continue to grow, even while you sleep. Before long it will be at $40,000, then $80,000 and so on. Time and careful direction of your dollar bill “employees” can build to over 1 million before you’re 50.

 At that amount, your team of hard-working dollars will give you about $40,000 annually for the rest of your life. Hopefully, you’re beginning to see the tremendous amount of freedom you can get with time and patience.

If you’re in the fortunate position of having extra savings after months of shutdown, make the most of this opportunity now and put those lazy dollars to work!

Need help investing your “lazy” dollars? Let’s work together to build your investments. Reply to this email or call me at 760-508-0368.

References:

Fitzgerald, Maggie. (May 29, 2020.) “U.S. savings rate hits record 33% as coronavirus causes Americans to stockpile cash, curb spending.” CNBC. Retrieved from https://www.cnbc.com/2020/05/29/us-savings-rate-hits-record-33percent-as-coronavirus-causes-americans-to-stockpile-cash-curb-spending.html