Save and Invest

Don't load up on cash, says money expert, even though some accounts now pay over 5% interest

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The Federal Reserve on Wednesday declined to hike interest rates further, but after months of aggressive increases, one thing remains certain among investors: Cash is back.

With interest rates hovering near zero for much of the last decade, savers couldn't expect to earn much in interest when they stashed their money. But with rates near 22-year highs, there may be reason to get your bills out of the mattress.

Online banks are offering high-yield savings accounts paying interest in the neighborhood of 5%. Rates on one-year certificates of deposit — a popular cash equivalent — pay over 5%. (Check out CNBC Select's lists of the best high-yield savings accounts here and of the best CDs here.)

All of that may have you wondering: Should my portfolio include some green stuff?

Yes and no, says Amy Arnott, a portfolio strategist at Morningstar Research Services. "I think a lot of people have been tempted to load up on cash, but there's still a pretty big opportunity cost in terms of long-term growth," she says.

"Instead of loading up, people should think about using cash appropriately, for emergency funds and short-term spending goals."

The advantages of holding (some) cash

As an investment, cash has a couple of advantages over things like stocks and bonds.

For one, it's more liquid than just about anything else you can own. You can use your cash to buy goods and services. If you want to purchase something using anything else, chances are you're going to have to convert it to cash first.  

For another, it doesn't decrease in value. And although the dollar is no longer pegged to a physical asset, such as gold, it's backed by the full faith and credit of the U.S. government. That means your $5 bill is going to be worth $5 for as long as you own it.

But there's a reason you don't just keep bills in a safe: inflation, which gradually erodes the spending power of your dollar. That's why it's generally advisable to park your cash in a vehicle that maintains liquidity and safety, but also gives you a chance to keep up with inflation.

At today's rates, you may actually be able to do better than that.

"The yields are definitely more attractive and rewarding than they've been in a long time," Arnott says. "You're actually staying ahead of inflation as long as inflation continues to moderate."

Different ways to hold cash

Different cash equivalents come with varying levels of liquidity, safety and potential yield. Here's a look at a few popular options.

1. High-yield savings accounts

High-yield savings accounts and money market accounts are both insured, up to $250,000, by the Federal Deposit Insurance Corporation. These offer the most liquidity this side of carrying cash around in your wallet, and are currently paying rates of around 4.50% to 5%.

2. Certificates of deposit

Certificates of deposit — commonly referred to as CDs — are accounts offered by banks and credit unions which come with higher yields than savings accounts, but have a term that ranges from three months to five years.

When the term ends, you get your money back, plus interest at a rate you locked in when you opened the account. Take out the money before the term ends, and you'll face an early withdrawal penalty. Banks set their own terms for these penalties, but they're often worth 90 or 180 days of interest.

These are FDIC insured and currently often come with yields at 5% or higher.

3. Money market funds

Money market funds are mutual funds that invest in short-term low-risk debt. They can be purchased through your brokerage account or directly from a mutual fund firm. There is a very small risk of losing money with these, and they generally pay attractive interest rates and can be quickly liquidated.

Versions offered by Vanguard, J.P. Morgan and Charles Schwab all pay more than 5.2% in interest.

4. Treasurys

Like CDs, Treasury bills come with different maturities, from one month to 30 years. Treasurys, like cash, are backed by the full faith and credit of the U.S. government, which has never defaulted on its debt.

You can buy these bonds directly from the Treasury's website or from your brokerage firm, but you'll have to sell them to raise cash in the event that you need money to spend.

A 4-month T-bill currently yields 5.61%.

When to hold cash — and when not to

How much cash to hold and what vehicle to use will depend on your personal situation.

As a rule of thumb, financial advisors generally recommend holding three- to six-months' worth of living expenses in a cash account that's easy to access. By keeping your emergency fund in cash, you avoid the risk of having to sell other assets you own, such as stocks, at a potential loss when something comes up.

"It's usually recessions when people tend to lose their job, which is also the worst time to try to sell a stock to raise cash to live off of," says Sam Stovall, chief investment strategist at CFRA. "Having some cash on the sidelines at all times is prudent."

Arnott says money market mutual funds and high-yield savings accounts both offer liquidity and competitive yields for those looking to build an emergency fund. "There's also the convenience factor, where you're easily able to transfer assets into different accounts."

Cash is also the way to go for short-term goals, such as saving for a wedding or a down payment on a home. If you have decent idea of when you need the money, it's not a bad idea to match the timeframe to the maturity on a T-bill or CD, especially since many financial experts think the Fed may stop hiking rates or even lower them — sending rates down across the board.

"You can get a 3.4% rate on a CD and lock it in for 10 years. That's pretty good," says Stovall. "You're only a loser if inflation continues to rise."

Were inflation to heat back up, the Fed could continue raising rates, but "I think the risk of that happening right now is pretty low," says Arnott.

As for your long-term money, you're likely better off in assets, such as stocks, that fluctuate more than cash, but that tend to deliver higher returns over time. That's because even though cash looks attractive now, it's historically done a lousy job keeping up with inflation.

"If you're looking at, say, your 401(k) or retirement portfolio, I don't think it makes sense to hold any type of cash in that type of account," says Arnott.

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