Choosing the Right Type of Account for Your Cash

While many people do not think of cash as an investment, it is often a substantial portion of your financial portfolio. Whether accumulated in checking or savings accounts or short-term certificates of deposit, you should make sure your money is working in the most effective way possible. Earning competitive returns on your "cash investments" should be part of your overall financial strategy.

Here are some thoughts to keep in mind as you create a plan for your cash investments.

• Liquidity and activity levels usually influence the interest rates offered on different types of cash accounts.
• Liquidity means how quickly you can access to your funds.
• Activity means how often you can use the account.
• Generally, accounts that allow more liquidity and more activity pay lower interest rates.

For example, a checking account, which provides convenient access to your money, will usually pay lower interest rates than a savings account that limits the number of monthly transactions. With a Certificate of Deposit (CD), you commit your funds for a certain term and earn higher interest rates. CD terms typically range from a three months to five years with the longest maturity CD usually paying the highest rate. However, CDs do not allow for early access without an interest penalty.

Here is a typical chart of interest rates for different types of accounts.

Choosing the best account, or combination of accounts, depends on how you use your cash. You may want to consider a strategy that combines two or three accounts for your particular cash needs. To illustrate, let us say you have a total of $10,000. A checking account that you use for regular monthly expenses, has a balance of $4,000. Your savings account, which you use to save for major expenses (i.e., vacation, new car, down payment on a house), or for unexpected expenses, has a balance of $6,000.

Using the example above, with $4,000 in your checking account and $6,000 in your savings account, you will earn total annual interest of $8.

But look what happens if you distribute your funds differently. Let us assume you can reduce your average checking balance by $1,000 and then use your savings account more as an emergency source of funds than as a longer-term accumulation account. The following example uses CDs of 3-month, 6-month and 1-year terms to earn higher rates, yet still provides liquidity for emergencies or making that major purchase at the end of the year.

Rearranging your cash into accounts that more effectively reflect your liquidity needs will earn you an extra $43 in a year.

Of course, you have to pay attention to the features of the accounts you choose for your cash investments. By taking into consideration how you use your money, however, you can improve the returns and possibly make that major purchase a little sooner.