It is hard to stay on top of your
personal investments when you are a business owner. Growing your business or
your new venture is your number-one priority. Sitting down and making
investment decisions for your own money often gets pushed wayside.
One thing you can do right now to
improve your investment situation is make sure you’re not making two very
common mistakes with any cash you have on hand. Maybe you need this cash to
re-invest in your business? Or maybe it’s there to pay off some debt in the
near-term? Regardless, optimizing where your cash is stashed is an easy fix
that a lot of entrepreneurs overlook.
Mistake #1: Leaving cash in
your savings account at your local bank.
Why? The
interest rate you’re paid per year on money you have sitting at your bank is
most likely around 0.05 percent to 0.10 percent on a good day. Even
when we take into consideration the slight increase in interest rates lately,
interest rates are still very low across the board.
The Fix: “Online”
high interest (or high-yield) savings accounts offer you up to 10x the interest
rate that any bank offers. Online
high-interest banks can pass on that cost savings to us in the form of higher
interest payments.
For example, Discover Online
offers an annual yield of 0.90 percent while the national average yield is
0.08 percent. While 0.90 percent still seems low, online high-interest
banks offer significantly better interest rates on your cash than your local
brick-and-mortar bank and you will see the interest payments add up over time,
especially as interest rates increase back to normal levels.
Mistake #2: Investing in a
“short-term” bond fund thinking your money is in “cash.”
Why?: When
you invest in a short-term bond fund, that fund takes your money and invests in
securities (mostly short-term bonds) that have high liquidity. Meaning, they’re
easily bought and sold. But here’s the problem: most people think their money
is sitting in cash when they are invested in a short-term bond fund, risk free,
but it’s not.
The short-term bond fund invests
your money in short-term securities that offer you a higher yield than your
cash sitting at your local bank. That’s great. The problem is, when advisors
recommend short-term bond funds as a place to “park your cash,” they often
forget to tell you that your money is now susceptible to interest-rate risk.
Bonds lose value when interest
rates increase. Why? Because you own an older bond that now pays you a lower
interest rate. The bond you own is now worth less since it pays you the old
lower interest rate. That is called interest rate risk. The Fed is expected to
potentially increase the federal funds rate at the end of this year. On one
hand this is good because you will eventually see an increase in the yield you
receive on money you have sitting in cash. On the other hand, this increase in
short-term interest rates will cause short-term bonds to lose value.
A huge misconception people have
is that short-term bond funds = money sitting in cash. That is 100
percent not true. You are invested in short-term bonds that will lose
value as interest rates increase. That is interest rate risk.
The Fix: Similar
to the above, a high interest account is a good way to maximize interest you
receive without having to take “interest rate risk” associated with investing
in a bond fund.
The bottom line is you’re busy
running a business and have very little time to manage your investments. Two
simple things you can do to make sure you’re maximizing the cash you have on
hand is explore a high interest online savings account and make sure you
understand the risks involved with your short-term bond fund investments.
