Over the past year, cash management has become an important topic of conversation with our clients. Prior to last week, the nature of that conversation has been about how to increase the yield, or interest earned, on cash. While short-term interest rates have increased, in many cases the yield available on bank deposit accounts has not kept pace.
On Friday, the Federal Deposit Insurance Corporation (FDIC) announced that Silicon Valley Bank was closed by its regulator. SVB’s closure is the second largest bank failure in U.S. history behind the 2008 collapse of Washington Mutual. For the first time since the financial crisis of 2008-2009, the potential risk of bank deposits is again front and center. This memo is about your cash management options. Specifically, we’ll review the basics of bank deposit accounts versus the cash feature in your brokerage accounts known as a money market mutual fund.
Bank Deposit Accounts
Banks offer various ways for customers to deposit their cash, such as checking accounts, savings accounts, and Certificates of Deposit (CDs). Banks use these deposits to make loans and other investments to earn a rate of return over and above the rate that they offer to their deposit customers. Occasionally, banks get into trouble and the FDIC steps in. The FDIC was created in 1933 to restore faith and confidence in the banking system during the Great Depression. The FDIC provides insurance in the event of a bank failure and also steps in to manage the process when a bank fails.
FDIC insurance covers up to $250,000 per depositor for each ownership category. Examples of ownership categories include individual accounts, joint accounts, and IRA accounts. If you have questions about how much FDIC insurance coverage you have for various bank accounts, the FDIC offers an online tool (https://edie.fdic.gov/calculator.html) that allows you to calculate your coverage. Uninsured deposits are at risk in a bank failure.
Money Market Funds in Brokerage Accounts
The money market fund in your brokerage account(s) operates in some ways like a bank account. Cash in the money market fund is liquid and available every day, and we can establish similar features, such as a check book and debit card.
Money market funds invest in short-term, high quality debt instruments. In other words, money market funds make short-term loans to entities with short-term borrowing needs, such as Government entities and corporations. Money market funds maintain what is known as a stable net asset value. The value of the fund does not fluctuate like other mutual funds. The net asset value of a money market fund typically remains fixed at $1 per share, and the fund pays dividends monthly, consisting of the interest earned on investments.
Unlike bank accounts, money market funds are not protected by FDIC insurance. However, we generally recommend money market funds that invest solely in securities issued by the U.S. Government and U.S. Government Agencies. In other words, the underlying investments in money market funds that we use for clients have the backing of the U.S. Government.
Most money market funds currently have an annual yield that exceeds 4 percent, which is greater than the yield that most banks offer on deposit accounts. This is not always true but is commonplace today.
To summarize, we generally prefer the current risk/return characteristics of money market funds to bank deposit accounts. If you wish to discuss your cash management needs, please reach out to your advisor. We are ready to assist.