Where Cash Should Live: Treasuries, Money Markets, and What Is Enough

Cash is the part of the balance sheet people manage least carefully, and it costs them in two ways. They hold far too much of it, out of habit or anxiety, and what they do hold sits in accounts paying a fraction of the rate available a few clicks away. Both are fixable. The fix starts with deciding how much cash the plan actually needs.

How much

Working households. Three to six months of essential spending, held for job loss, medical events, and the roof leak that shows up the week the car dies. Households with variable income (commissions, business owners, equity-heavy pay) should hold toward the high end or beyond; two-income households with stable jobs can sit toward the low end. Beyond that reserve, plus cash for anything you're buying in the next year or two, extra cash is money that could be working.

Retirees. The job changes here. What keeps a retiree from selling stocks in a decline is the portfolio's bond allocation, sized to several years of the amount the portfolio must supply (spending minus Social Security, pension, and other income); see the bucket strategy. Cash is the short end of that: a few months of withdrawals, held so the monthly transfer never waits on a trade. A retiree whose Social Security covers all essential spending needs less; one drawing heavily from the portfolio needs more.

Everyone. Known large expenses in the next one to three years: a tax bill on a Roth conversion, a home purchase, tuition, a car. Money with a date on it belongs in cash or a bond maturing on that date, not in stocks.

Cash beyond those purposes isn't safety. It's an allocation to an asset that has lost to inflation over most long periods. A household holding $500,000 in a savings account "to be safe" is making an investment decision, and usually the wrong one.

Where

Bank checking and savings. Convenient, FDIC-insured to $250,000 per depositor per bank per ownership category, and at the large banks paying a rate that rounds to zero. The operating account should hold a month or two of spending. No more.

High-yield savings accounts at online banks pay within a point or so of the short-term rate, are FDIC-insured, and move to checking in a day or two. Interest is fully taxable, federal and state (Florida has none). A reasonable home for a working household's reserve.

Money market funds. Mutual funds holding short-term government and corporate paper, priced at $1 a share, paying close to the short-term rate. Treasury and government money market funds hold only government securities, and their income is largely exempt from state income tax, which doesn't matter in Florida but matters to clients elsewhere. They aren't FDIC-insured; the government paper they hold is the protection. They're available in any brokerage account, which makes them the natural spot for a retiree's reserve, right next to the portfolio.

Treasury bills. Direct government obligations of 4 to 52 weeks, bought at auction through a brokerage or TreasuryDirect, paying the short-term rate exactly, exempt from state tax, and as safe as the dollar. A ladder of bills maturing monthly or quarterly is a reserve that yields the full rate with no fund expense. The cost is attention. Somebody has to roll the ladder.

Brokered CDs. Bank CDs bought through a brokerage, FDIC-insured, sometimes yielding a bit more than Treasuries for the same term, and tradable before maturity at market prices. Useful for a dated need when the CD rate beats the Treasury rate.

Not a bank's own money market account (usually a savings account with a different name and the same low rate), a "cash management" account at a brokerage that sweeps to a low-rate bank deposit by default, or anything that locks your money up for a rate barely above the alternatives.

The default sweep

Most brokerage accounts sweep uninvested cash into a bank deposit program paying well below the money market rate. On a $200,000 reserve, the difference can be several thousand dollars a year. Checking the sweep option and switching to a Treasury money market fund, or just buying the fund with idle cash, is a five-minute task most account holders never do. It's one of the first things we look at in a new client's accounts.

Taxes

Interest from bank accounts, money market funds, and CDs is ordinary income. Treasury interest is exempt from state and local tax. For a Florida resident that distinction doesn't change the bill, but it matters for anyone who may move or who has family in a high-tax state. In a taxable account, the reserve's interest adds to AGI and can bump into the thresholds retirees manage (IRMAA, Social Security taxation, the ACA subsidy). One more reason to size the reserve to the need and not beyond.

Money that belongs to the portfolio's bond allocation rather than the household's cash reserve is held in Treasury funds, usually in a retirement account where the interest isn't taxed every year. That's the asset location logic.

Rates change

Short-term rates rise and fall with the Federal Reserve. When they're high, cash is a fine place for the reserve and a bad place for long-term money, because long-term money should be earning the equity premium. When they're low, cash is still where the reserve belongs, because the reserve's job is availability, not yield. So the amount of cash gets set by the plan, not by the rate. Where it sits should be wherever earns the most for the same safety, and that changes, so it's worth a look once a year.

What we'd do

Every client plan spells out the cash: how much, for what, and where. The operating account at the bank stays small, the cash sits in a Treasury money market fund or bill ladder in the brokerage account, the sweep option is set correctly, and the transfers are automated. It's a small piece of investment management, and for a lot of households it recovers thousands of dollars a year that were being handed to a bank for nothing.

Frequently asked questions

Joseph G. Valerio, CFP®, EAFounder and Lead Advisor at Valerio Wealth Management, a fee-only, fiduciary virtual family office in Miami, Florida. One advisor, credentialed in both financial planning and federal tax. About Joseph

This article is general education, not individualized advice, and it is not tax, legal, or accounting advice. Figures reflect federal law for the year stated and can change. Valerio Wealth Management does not prepare or file tax returns. Speak with a qualified professional about your own situation before acting.