Leverage reserve money to provide cash cushion

In both booming and challenging times, it’s wise to have some extra money set aside for life’s unexpected hardships. And an economic slowdown isn’t the only reason you might need to pull from your cushion of cash. You could find yourself facing unemployment, medical bills, divorce, the death of a loved one, a natural disaster or another emergency situation, and your cash reserve can help you through these unexpected obstacles.

Yet due to rate cuts by the Federal Reserve System, the places where you may have traditionally kept your cash cushion — CDs, money markets and interest-bearing checking and saving accounts — may not be earning the amount of interest they once did. For this reason, here are some ideas to consider and discuss with your financial adviser about making the most income on your cash reserve.

SHORT-TERM, HIGH-YIELD CDS

When it comes to certificate of deposits, a high-yield CD typically will earn you the most interest yet generally requires a larger investment and longer terms. Although choosing the highest CD rate can be tempting, it is only one factor to consider.

If you can make a smaller investment for a shorter period of time — even at a lower rate — it could be a smarter decision for you down the road. Especially if there is a chance you’ll need the money sooner than expected, which could result in an early withdrawal fee.

Also, sit down with your financial adviser to talk about the best available rates and any special incentives your financial services company may be offering. Since many companies require you to open a checking account in order to become eligible for special rates and offers, it could be worth checking with your financial services company first. Your financial adviser can help you determine the best solutions for your personal situation and review the terms that are the most comfortable for you.

MUNICIPAL BONDS

Although they’re not risk-free, municipal bonds are as safe as or safer than just about any other investment option. And unlike CDs and money market accounts, your earnings could be tax-free, while earning a higher rate of return.

So what are municipal bonds? State and local governments issue municipal bonds to fund their civil improvements. And although these earnings are tax exempt, you typically receive a lower interest rate on a tax-free bond because of the tax advantages. And keep in mind that any capital gain you receive from the sale of a municipal bond is fully taxable.

Depending on your unique situation, you might be better off with a higher interest rate, taxable bond, especially since tax-free municipal bonds make less sense for people in lower tax brackets where the tax savings is only as great as their marginal tax rate. Be sure to talk with your tax adviser and financial consultant about which option is best for you.

PAYING OFF DEBT

It really doesn’t make much sense to earn 2 percent on your cash reserve while paying 12 percent or more on your credit card debt. If you have accrued high credit card balances and are paying only a portion or the minimum payment each month, it may be financially smart for you to use your cash cushion to pay back your debt. Particularly when your interest rate could be significantly increased from a late or missed credit card payment.

In addition to your credit card, consider other loan debt you may have — such as auto, student and mortgage — and determine if you’d be better off earning interest on your cash reserve in high-yield CDs and municipal bonds or paying off these loans. And keep in mind that some loans come with prepayment penalties, which can eat away at the advantages of making early payments.

Because emergencies are by nature unexpected, and the purpose for having a cash reserve is to help you pay for them, you’ll want to weigh the pros and cons of your individual circumstances. It’s important for everyone to have quick access to cash, especially if you can’t count on a pay raise or if your credit score would make it difficult for you to qualify for a home equity loan.

Take a moment to review how much money you’re earning on your savings and then set an appointment with your financial adviser to find out if you could be making more. And if you’re considering investing your cash cushion in the stock market, be sure to evaluate your tolerance for risk and invest only what you can afford to lose. In the end, remember that nothing is as safe as your interest-bearing checking and savings accounts.

Doris Charles is the regional president for Wells Fargo in Southern Nevada.

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