It’s really common for us to work with clients, or chat with friends, who are fortunate to have extra money on hand, but they don’t know what to do with it so it sits in cash in a bank account. This is so common for our generation! Many of us aren’t 40 yet, but we’ve now experienced two periods of economic and job uncertainty. We cling to our cash like it’s some kind of security blanket.
Decisions get even harder to make if you receive an inheritance or settlement. That money often gets mixed with lots of emotions because you’re grieving for the loved one who left you that money, or you’re recovering from the accident that resulted in the settlement. This money may be life-changing — overnight, you can afford to buy a house, pay for grad school, or completely pay off your debts. But what if you blow that precious money on the wrong thing? It’s easier to do nothing than do the “wrong” thing.
With so much at stake, it’s totally understandable to put your money where you can see it: a safe, FDIC-insured checking or savings account. Parking your money there temporarily while you strategize is a smart move. But if you let that cash sit for years, it loses value because of inflation, and you lose out on opportunities. Here are some excellent ways to put your money to work for you.
Move money from checking to a high-yield savings account
If all your savings are actually in a checking account, you’re earning a pittance when it comes to interest. Even though high-yield online savings accounts are earning lower interest rates right now than they were last year, they’re still miles ahead of checking accounts and most savings accounts at big banks.
Keep enough in checking to pay your rent or mortgage, credit card bills, utilities, and other monthly expenses. Make sure your balance doesn’t drop to a level where you’d have to pay a fee, because some checking accounts require higher minimum balances. Any other cash you need in the next three years or less can be moved to a savings account. You’ll still be able to move money back into your checking account if you need to, but until you do, it’ll earn more interest.
I’m a fan of automating savings. You can set up a monthly automatic transfer from checking to savings, or even divide your direct deposit from work into multiple accounts.
Pay down debt
You won’t believe how often I see a client sitting on $50,000 in cash, but they’re still making minimum payments on the last $5,000 of a student or auto loan. Get rid of the debt! Unless you have a more pressing need for that money, get an immediate return on your investment by paying off the rest of what you owe.
Even if you have a low interest rate on those loans, freeing up additional monthly cash flow can be extremely helpful especially if you redirect the money you were putting towards debt towards your other financial goals.
Give your savings some jobs
Map out the next few years. Do you plan to buy a house? Replace your car? Send your kid to private school? Renovate a bathroom? Start putting your savings into buckets so you can begin to budget for each goal. Ally Bank, for example, allows you to divide the money in one account into up to 10 buckets, and you can even decide how much money goes into each and how any new deposits get divided across them.
The simple act of deciding what, exactly, your money is for can help you begin to feel unstuck. The money begins to represent possibilities instead of being something you’re afraid to deal with.
Save more for retirement
Contributing enough to your company’s 401(k) to get the employer match is an excellent start, but you can do more if you have a lot of unspoken-for cash on hand. If you haven’t opened a Roth IRA yet and your income doesn’t exceed the limit to contribute, you can invest up to $6,000 for 2020. (The income limits for 2020 are $139,000 for individual filers and $206,000 for married filing jointly.) If you already have a Roth IRA, you can make that 2020 contribution anytime before April 15, 2021.
Still have more cash available? Return to your 401(k) and increase your contributions. This has the added benefit of lowering your taxable income even further. It’s also a great time to increase your 401(k) if you’ve recently paid off other debt and therefore freed up additional cash flow. You don’t want that money to get eaten up by other monthly spending, so increase your 401(k) contributions to keep your cash flow similar.
Please don’t be that person who has $75,000 sitting in savings, but is failing to max out their 401(k) every year because they’re scared to see the balance on their savings go down. You can save a significant amount in taxes by maximizing your 401(k) with $19,500 per year (bonus points if you have a spouse who can also do the same!).
Begin investing for other goals
Save up for medium-term goals (anything more than three years from now) by opening a taxable brokerage account. You can do this at a well-known brokerage like Fidelity or Vanguard, or open a robo-advisor account through a company like Betterment. You don’t have to get fancy with stock picking! Keep it simple with low-fee index funds or ETFs. You’ll have a diversified portfolio for a lower cost and way less effort.
It’s important to consider investing this money less aggressively than you would a retirement account if you think you might need the money in the next decade. If you’re not exactly sure what you’d like to use this money for, that’s ok, but consider having more bonds and less stocks in this portfolio so you don’t take unnecessary risk with this money.
A taxable brokerage account is a great way to build wealth over the long term and many of my clients who started investing before they knew exactly what they wanted to use the money for, were glad that they had it a few years later when they needed it.
The power of moving forward
Getting unstuck and giving your money a purpose is a great way to build wealth over time. In terms of what to do with your extra cash: take care of any remaining debt, then make sure you have at least 3 months of living expenses for emergencies in a high-yield savings account, then work on maximizing your retirement accounts. Once you’ve done these three things, you’ll have a solid financial foundation and it’s time to plan for other short term goals in the next three years.
Once you’ve mapped out your goals over the next few years, it’s time to invest in a brokerage account so that you leave some flexibility in your plan for when life changes head your way.