Most people take a simple view of cash: they have a checking account for spending and a savings account for savings, and if they get fancy, they’ll have a CD for longer term savings goals. Power users will change to an online bank with better returns, and that’s about as far as it goes. That certainly works, but we can do a lot better with few downsides and a lot of extra benefits.
I’d like to start with explaining how traditional banks work and then look at alternatives. Basically, banks make most of their money by lending it, either for mortgages, auto loans, credit cards, etc. Federal regulations require they keep a certain percentage of their assets in “cash,” so they pay interest on checking and savings accounts to attract deposits. The larger the bank, the less they need to work for deposits since they have brand recognition. That’s why you’ll see higher interest rates at online only banks (e.g. SoFi, Ally, etc) than at huge brick and mortar banks (Wells Fargo, Chase, etc), they need to pay more to attract customers since they don’t have branches to do so. However, they’ll never pay more than a certain percentage of loan rates, otherwise they’ll lose money. Switching banks is time consuming, so customers rarely do that, which means banks only need to have periodic promos to encourage people to move their money to them.
Let’s compare that to a brokerage. Brokerages offer a variety of features, and most of their money is made on commissions from trades (or for free brokerages, bid/ask spreads) or from fees on funds they run. The friction in changing funds is pretty low, so funds often compete for low fees to attract investors, and the more investors they have, the lower their fees can be (managing $1B isn’t that different from managing $10B in terms of costs). They sometimes offer loans (e.g. margin loans), but that isn’t the core of their business, and those loans are backed by the debtor’s own assets, not the brokerage’s funds, so risk is much lower and not related to deposits by other customers.
So now that the high level differences between banks and brokerages are out of the way, let’s look at products brokerages have and how they line up with traditional banking products:
- Money Market Funds - basically savings/checking accounts, but run by a fund manager instead of a bank; you can select from any number of money market funds, from funds that look to reduce taxes (e.g. buy mostly Treasuries) to funds that seek to maximize returns; interest is generally accrued daily and paid monthly; banks sometimes offer money market accounts, which are similar, but they operate a bit differently, and you only get the one they offer
- brokered CDs - similar to regular bank CDs, but you’re buying them on the open market instead of from your bank; these CDs cannot be broken early like bank CDs, but they can be sold on the market like any stock for the current fair market value; this means they can reduce in value if you sell before maturity, but since you’re able to shop for the best price, you usually get a much better return if you hold to maturity
- t-bills/notes/bonds - similar to brokered CDs, but issued by the federal government in increments of $1000; these are not subject to state and local taxes, and some brokerages allow them to be auto-rolled (when they mature, the same denomination will be purchased); there’s no early redemption, but they can be sold at any time for fair market value
- municipal bonds - buy bonds directly from cities and whatnot; these are usually not subject to state, local, or federal taxes, but also have higher risk due to cities generally being less credible debtors than state or federal governments; I don’t bother with these, but maybe they’re worthwhile in states with higher taxes (mine is <5%, so not that high)
Generally speaking, the brokerage options over a greater return than traditional banking products because it’s trivial for investors to switch products without changing brokerages.
Here’s what I do:
- checking/savings - invested at Fidelity in SPAXX, which currently yields ~5%, and I think it’s ~30% state tax exempt; if my state had higher taxes, I’d probably opt for a Treasury-only fund; switching takes like 30s to enter a trade; Ally Bank savings is 4.25% and money market fund is 4.4%, and I use my brokerage as checking, so I’m getting 5% on all money held there (Ally checking is 0.10%)
- CD - I had a no penalty CD @ 4.75% @ Ally, which was a fantastic rate when I got it; Fidelity offers non-callable CDs @ >5% for periods from 3 months to 5 years, and Ally only offers those rates for 6-18 months (and they’re still lower than Fidelity); I don’t buy any because I buy…
- Treasuries - no equivalent at banks, but they’re close enough to CDs; current rates are 5.2-5.4% depending on term (4 weeks to 52 weeks), and even notes (2-10 year terms) are 4.5-5%; my efund is invested in a t-bill ladder; I bought 13-week (3-month) t-bills every other week and set them to autofill, and my gains live in my money market fund (SPAXX @ 5%); this is half of my efund, with the other half in ibonds; if I need money, I either cancel the autoroll, or I sell the t-bill on the market
Here’s my list of pros:
- significantly higher interest in checking (5% vs ~0.10%); no difference between “checking” and “savings,” they’re all just brokerage accounts
- more options for investment - I now feel comfortable keeping my efund, checking, and regular savings in the same place without having to sacrifice returns
- debit card rocks - Fidelity and Schwab both have worldwide ATM fee reimbursement and low/no foreign transaction fees (Fidelity is 1%, Schwab is 0%)
- can have cash savings and investments in the same place - Fidelity also has my HSA, and I may eventually move my IRA as well
- paycheck comes a day earlier - lots of banks offer this, but often only on their checking accounts
And some cons:
- SIPC instead of FDIC insurance - coverage is about the same, but FDIC is automatic, whereas SIPC requires me to make a claim; I doubt I’ll ever need either
- a lot more options means the UI is a bit more complex; once familiar, it’s not an issue
- some services don’t play nice with brokerages - I keep an Ally account around just in case, and I honestly haven’t noticed any real issues (sometimes I can only link accounts one way, but that’s not an issue)
I switched from Ally to Fidelity last year for my primary bank and I’m loving it, and I highly recommend others give it a shot. If Fidelity isn’t your speed, Schwab works well too. Vanguard doesn’t offer a debit card, otherwise I’d recommend them as well (their money market funds are even better than Fidelity’s). I used to shop around for better savings rates, and now I don’t bother because Fidelity beats all of them on features and average returns (e.g. a better savings rate still loses if checking is near 0%).
Feel free to ask questions.
I think of my checking account as a buffer - direct deposit goes in, bill pay goes out, any amount beyond this month’s bills goes to/from brokerage. My particular account has a minimum balance and the actual balance hovers right around there. Any interest lost/earned on that balance over a year isn’t enough to worry about, and no payee/payer ever sees the magic numbers to access my real savings.
The key is not to have cash just sitting around, regardless where. If you don’t have immediate need, get it into investments. Modern mutual funds or ETFs are liquid enough to serve as emergency fund - unless your ‘emergency fund’ is something you dip into every other month. While interest rates are so high, it may not feel pointless to keep cash, but even those high rates are only 1-2% above inflation (and have only risen above inflation recently). Get your money back into the economy; don’t pay a banker to do it for you.
Yeah, the extra interest isn’t a ton. I was already keeping my checking balance pretty low, so the extra interest is something like $4-5/month (average balance is like $1k). That’s not life changing money by any stretch, but it still adds up, and I didn’t need to do anything for it other than move where my autopay goes.
The more important thing to me is being able to consolidate accounts. I’m going to have a brokerage account anyway, so I was able to move my checking and savings to it, plus my efund (was at Treasury Direct in ibonds), and I get an extra $50-60/year as well.
But are they dependable enough? Let’s say the market crashes 30-50% and you lose your job at the same time, how would you feel if your 6-month efund became 3 months overnight?
Also, how big of a difference would that be overall financially? As in, what percentage of your net worth is that efund? When it’s a big part of your net worth, it’s a bigger hit if you lose your job in a market downturn, and if it’s a small part of your net worth, the difference in returns won’t be huge.
So that’s why I keep my efund in stable investments. I don’t hold bonds in my portfolio, so I just treat my efund as my bond portion, and it’s currently a fair bit less than the 10% experts recommend for bonds, so I don’t really see a point to go even more aggressive.
So, definitely coming from a position of privilege, but I think of a 6 month efund sitting at 2% (historical) MMA or having a couple of 10-20% years. If you’re looking at an efund that’s 105% of what you put in vs 150%, then that crash is a much smaller concern. Especially because the actual nadir of values (at least in the last 30 years) has been quite short lived. Why I distinguish between emergencies and events that happen once or twice a year: personal emergencies are kind of likely to coincide with stock market dips/crashes, but there’s a lot of growth potential in the meantime. I have taxable and tax-sheltered investments, and don’t distinguish a specific efund.
Risk tolerance is definitely a thing, though. I was 98% equities, 2% cash for 20 years, and only started getting some junk bonds when the yields got above 7%.
And that’s why percentage of invested assets matters.
If your efund is 50% of your invested assets, you’re probably near the beginning of your working career and a layoff is somewhat likely in a downturn. So if that happens, you could burn through all of your assets in the time it takes to find a new job, and that sucks. If your efund is 10% of your invested assets, losing half of your efund won’t really matter all much because you have other assets to back you up. But also having 10% of your invested assets in secure investments also won’t drag your growth all that much since a 90/10 stock/bond split has almost identical performance vs 100/0. If it’s significantly <10% of your invested assets, you’re nearly or already capable of retiring and don’t need an efund anymore (2% is that magic number assuming a 6 month efund).
I personally am in a single income family with kids, so having cash to pay for necessities is really important to me. In fact, I had 12 months when I was working as a consultant, which I’m glad for because COVID killed all of my contracts and nobody was hiring, so I lived on that cash for the better part of a year. When I was single, my efund was much smaller because I had the option of moving back home, sleeping on a friend’s couch, etc if things went sideways.
So the more screwed you’d be if you lost your job, the more of your efund you should have in cash.
I personally keep about 3-6 months of expenses in tbills, and I have a taxable brokerage account with more assets if necessary. I also keep about a month of expenses in cash in my money market funds as slush between paychecks. Other than that, the rest of my assets are in stocks, as in, pretty much 100% stocks in a 70/30 domestic/international split. I happen to need <10% of my assets for my efund, but I’m still unwilling to part with it because it saved me when I lost my job (and the phenomenal returns right now certainly help). So I just count it as the bond portion of my portfolio and call it a day.