Download BM200-08 Cash Management 9May05

Personal Finance:
a Gospel Perspective
Cash or Liquid Asset
Management
Day 6 Objectives
A. Understand the importance of good cash
management and how it can help you achieve your
goals
B. Understand the different cash management
alternatives?
C. Understand that while technology can help, unless
you plan and spend at least 1-2 hours a week
following your finances, you will not be able to keep
up with your financial goals
D. Understand the different types of financial
institutions, and how they can help you meet your
financial goals (and pay you the most on your liquid
savings)
Your Personal Financial Plan
• Section VI: Cash Management
• What is your current Cash Management
Framework?
• What are you earning on your Savings?
• What costs/fees are you paying?
• What are you earning on your Checking?
• What costs/fees are you paying?
• Which Cash Management vehicles should
you be using and why?
Application
• You are with a friend who heard you have taken
Personal Finance at the Marriott School. She just got
married two months ago, and she and her husband
were given $3,000 as a wedding present. She will be
graduating in two years, and she and her husband want
either to save the money for law school when she
graduates or to use it to go on a vacation before law
school. Her husband wants to invest the money in the
stock market—he has two stocks he really likes, but
she is unsure of what to do. She asks for your advice.
What should you tell her?
A. Understand the Importance
of Good Cash Management
• What is cash management?
• The management of cash and liquid assets to help
you meet your personal goals
• What needs does cash supply?
• The need for liquidity--protection
• Liquidity enables you to have immediate access
to your funds
• It keeps you from selling less liquid long-term
investments at substantial discounts
Cash Management: the Tradeoffs
• Key Cash Management tradeoffs:
• 1. The Risk-Return tradeoff
• Higher liquidity means lower returns
• 2. The Spending-Investment Risk tradeoff
• Cash on hand is easier to spend than investments
• 3. The Time Expended-Return tradeoff
• Returns are smaller, so time expended should be
smaller.
• However, you still can impact your portfolio in a
big way by using liquidity wisely—get into the
habit!
The Key: Relate your Personal Goals to
Cash Management
 What do you want to accomplish?
Let Cash Management help you
• Want to save more money?
• Automate Savings: Pay Yourself First and Just
Do It!
• Do it through payroll deductions or
automatic deposit
• Want to shorten your time working on finances?
• Use cash management/budgeting software
•
Cash Management:
Your Emergency Fund
• What is an Emergency Fund?
• It is a resource that can be used to meet unexpected
needs for cash
• How much should include?
• The traditional rule of thumb is for sufficient liquid
assets to cover 3-6 months of expenses. I changed
expenses to income so you won’t ever need to tap
into long-term money to meet current needs
• Is it still wise to have this emergency fund in this
world of credit cards and home equity lines of credit?
• Yes—perhaps even more so
B. Understand
Cash Management Alternatives
• There are lots of alternatives, each of which has their
benefits and costs
• Checking accounts
• Savings accounts
• Money market deposit accounts
• Certificates of deposit
• Money market mutual funds
• Asset management accounts
• U.S. Treasury bills, U.S. Series EE bonds, U.S.
Series I Bonds
Cash Management (continued)
• Traditional Cash Management Instruments
• Checking accounts
• Liquidity: Very liquid, daily
• Required minimum balances: low
• Interest rates: Fixed, but minimal, currently 0%
to 1.2%
• Safety: Very -- FDIC insured
• Penalties for early withdrawal: No
• Source of information: banks and credit unions
• How to invest: contact a bank or other financial
institution to set up an account
Checking Account Rates over Time
Source: Bankrate.com 5/3/05
Cash Management (continued)
• Savings accounts
• Liquidity: Very liquid, daily
• Required minimum balances: Low
• Interest rates: Fixed, but minimal, currently
.25% to 3.30% (at UFB direct WSJ C2)
• Safety: Very --FDIC insured
• Penalties for early withdrawal: No
• Source of information: traditional and internet
banks
• How to invest: contact a bank or other financial
institution to set up an account
Savings Rates over Time
Source: Bankrate.com 5/3/05
Cash Management (continued)
• Less Traditional Alternatives:
• Money Market (Deposit) Accounts (MMA or MMDA)
• An alternative to a commercial bank’s savings account
• Liquidity: Very liquid, daily
• Required minimum balances: Higher than savings
• Interest rates: Variable, but higher than savings,
currently .50%-2.51%
• Safety: Very – FDIC insured
• Other features: Limited check writing
• Penalties for early withdrawal: No
• Source of information: Bankrate.com)
• How to invest: contact a financial institution to set up
Money Market Accounts over Time
Source: Bankrate.com 5/3/05
Cash Management (continued)
• Certificates of Deposits (CDs)
• Pays a fixed rate of interest for a fixed period of
time
• Liquidity: Less liquid, generally monthly,
depending on maturity
• Required minimum balances: Higher
• Interest rates: Higher rates, currently 1m 3.05%,
3m 3.16%, 6m 3.39%, 5 yr 4.21% (C2)
• Safety: Very – FDIC insured
• Other features: None
• Penalties for early withdrawal: Yes
• Source of information: WSJ page C15 Money
Rates
• How to invest: contact a financial institution to
purchase a CD
CD Rates over Time
Source: Bankrate.com 5/3/05
Cash Management (continued)
• Money Market Mutual Funds (MMMFs),
• Pool funds from many investors to buy higher
priced securities
• Liquidity: Very, daily
• Required minimum balances: Much higher
• Interest rates: Higher, with current rates: 0.5%1.2%
• Safety: Not FDIC insured
• Other features: Limited check writing, charge
administrative fees, bought by the share
• Penalties for early withdrawal: No
• Source of information: Brokers, www.bankrate.com
• How to invest: contact a mutual fund company
to set up an account and purchase a fund
Cash Management (continued)
• Asset Management Accounts
• Offer comprehensive financial services
• Liquidity: Very, daily
• Required minimum balances: Higher
• Interest rates: Higher, currently 0.75%-2.25%
• Safety: Not insured
• Other features: Checking accounts, credit cards,
loans, brokerage services, overdraft protection,
• Penalties for early withdrawal: No, but charge
higher annual fees ($50-125)
• Source of information: Brokerage firms
• How to invest: contact a financial firm to set up
an account
Cash Management (continued)
• U.S. Treasury Bills
• Short-term, less-than 12 months, government debt
•
•
•
•
•
Liquidity: Somewhat, monthly
Required minimum balances: Much higher
Interest rates: Higher, currently 3m 2.69%, 6m 3.085%:
Safety: Very, guaranteed
Other features: state and local income tax exempt, and
purchased at a discount, but don’t accrue periodic interest
payments
• Penalties for early withdrawal: Yes
• Source of information: WSJ page C15 Money Rates
• How to invest: 3 or 6 month bills can be purchased from
www.treasurydirect.gov, and other bills from banks/brokers
Treasury Bills over Time
Cash Management (continued)
• U.S. Series EE Bonds
• U. S. government savings bonds
• Liquidity: Somewhat, after 5 years
• Required minimum balances: Higher
• Interest rates: Higher, 3.5% fixed through Oct05
• Safety: Very
• Other features: State and local income tax exempt,
issued at half their face value, interest tax-free if spent
on eligible college tuition, sold in $25 to $10,000 bonds
• Penalties for early withdrawal: 3 month before 5 years
• Source of information: http://www.savingsbonds.gov/)
• How to invest: can purchase via the above website
Cash Management (continued)
• US Series I Bonds
• U.S, Government Savings bonds linked to inflation
• Liquidity: Very, after 5 years
• Required minimum balances: Minimal
• Interest rates: Linked to inflation, 4.80 until Oct05
• Safety: Very, guaranteed
• Other features: taxed only in year cashed, interest taxfree if spent on eligible college tuition, interest income
free from state and local taxation, sold in $25 to
$10,000 bonds
• Penalties: Yes, 3 month penalty before 5 years
• Source of information: www.treasurydirect.gov
WSJ 4May05 C15 Bankrate.com
Comparing Cash Management Alternatives
• How do you compare different alternatives?
• 1. Use comparable Interest rates
• Look at the Annual Percentage Yield (APY)
• The APY is the yield or return number you
should use when comparing different cash
management alternatives
• Financial institutions are required by law to
state the APY which converts the different
interest rates into similar compounding periods
• 2. Consider safety
• Some alternatives are explicitly or implicitly
guaranteed by the government
Comparing Alternatives (continued)
3. Use comparable after-tax returns
• A. Calculate the after-tax return of taxable assets
• After tax return = taxable return (1- tax rate)
• Tax rate = (Federal + State + Local taxes)
• B. Calculate the equivalent taxable yield (ETY) for
tax-advantaged assets
• The ETY is the yield that is offered on a
comparable taxable bond to give the same aftertax yield as a tax-advantaged security.
• 4. Consider inflation
• Calculate your return after the impact of taxes and
inflation
Application:
Calculating After-tax Returns
• Calculate the after-tax return for each of the
following bonds for Bill and Suzie. Bill is an
investor in the 15% federal marginal tax
bracket and 7% state tax bracket. Suzie is an
investor in the 35% Federal tax bracket and 7%
state tax bracket. Which bonds should Bill or
Suzie purchase?
• A 6.5% corporate bond (all taxable)
• A 4.75% municipal bond (federal tax-free)
• A 5.0% treasury bond (state tax-free)
Answer
• Bill (After-tax return = taxable return (1- tax rate))
• 6.5% Corporate Bond
• 6.5% * (1 - (.15 + .07) = 5.07%
• MB: 4.75% * (1 - .07) = 4.42%
• TB: 5.0 * (1 - .15) = 4.25%
• The corporate bond is the best for Bill
• Suzie
• CB: 6.5% * (1 - (.35 + .07) = 3.77%
• MB: 4.75% * (1 - .07) = 4.42%
• TB: 5.0 * (1 - .35) = 3.25%
• The municipal bond is the best for Suzie
Application: Calculating
Equivalent Taxable Yields
• Assume you are in the 25% federal and 7% state tax
bracket. What is the equivalent taxable yield to you of
a U.S. Series I bond that earns 4.8% and where the
principle and interest are:
• A. Planned to be used to pay for your child’s
college tuition expense?
• B. Planned to be used to save for family personal
goals?
Answer
• A. If you use the principle and interest for tuition, the
bond is both federal and state tax exempt.
• Return after tax = return before tax * (1 – tax rate)
• Since this asset is federal and state tax-free, the
equivalent on a taxable bond would be:
• 4.8% = x *(1 – (.25+.07)) or x = 4.8% / .68
• x = 7.06%
• B. If the bond is used only for personal expenses, it
is only state tax free. The equivalent on a taxable
bond would be:
• 4.8% = x * (1 - .07) or x = 4.8% / .93
• x = 5.16%
Application: Calculating After-tax
After-inflation Returns
• Calculate the real rate of return to a taxpayer in
the 35% federal marginal tax bracket and 7%
state on a $50,000 money market account,
assuming 4.5% yield and 3.5% inflation. What
are the implications of this result for cash
management decisions? (Note: the dollar
amount is not necessary for this calculation)
Answer
• After-tax return = return (1-federal + state tax
rate)
4.5% (1-.42) = 2.61%
Real Return = (1+ after-tax return) -1
(1 + inflation)
(1.0261/1.035) –1 = -.86%
It is very difficult to do much more than keep up with
taxes and inflation with liquid assets. Only the
amount need to meet immediate emergency needs and
short-term goals should be here. The result is worse
when you factor in charitable giving.
Questions
• Do we understand the importance of cash
management in helping us reach our goals?
C. Spend the Time Necessary
• While technology can help, unless you plan
and spend at least 1-2 hours a week following
your finances, you will not be able to keep up
with your financial goals.
• Set aside the time and use it wisely
Spending Time (continued)
• From the book, the Millionaire Next Door it states:
• People who become wealthy allocate their time. . in
ways consistent with enhancing their net worth.
[They] allocate nearly twice the number of hours
per week to planning their financial investments as
[those who do not become wealthy] do. (The
Millionaire Next Door, p. 71)
• Unless you are spending 1-2 hours a week on your
financial oversight, budget, investing process, it will
be very difficult to reach your goals.
Spending Time (continued)
• Set aside the time, once a week, to:
• Review and update your goals and what you
want to accomplish in life
• Update your budget—how are you doing
• Balance your checking/cash management
account, and
• Ensure all charges/balances are correct from
your credit cards/EFTs
Spending Time (continued)
• Fixing Errors
• Be alert to human and computer errors.
• Never deposit cash in an ATM.
• Call the institution that made the error.
• Write the institution within 60 days of
receiving your statement.
• Write the Federal Reserve Board’s Division
of Consumer and Community Affairs if
problems are not resolved
Questions
• Do you have any questions on the need to
spend 1-2 hours each week on your finances?
D. Understand the different Types
of Financial Institutions
• There are two main types of institutions (but
the distinction is blurring through
deregulation)
• “Banks” or deposit-type financial
institutions
• Non-deposit-type financial institutions
• The choice of which one you use depends on
which will serve your needs the best
Financial Institutions (continued)
• Deposit-type Financial Institutions
• Commercial banks
• Offer the widest variety of services. Generally
do not offer the highest rates, as they compete
with a broad range of services
• Savings and loan associations
• Slight ownership differences, but essentially
similar to commercial banks. May offer higher
rates.
Financial Institutions (continued)
• Credit unions
• Similar to above, but since not-for-profit,
can offer sometimes higher rates on
savings
• “Net” banks
• Electronic banks that pay more for
deposits, but have no local branch
network so lower costs and higher rates.
Financial Institutions (continued)
• Non-deposit Type Financial Institutions
• Mutual funds
• You can now write checks on your mutual fund
account
• Stockbrokerage firms
• You can also write checks on your brokerage
account
Financial Institutions (continued)
• Both Banks and non-Banks can offer on-line
financial services which allow access to bank
balances and some resources 24 hours a day.
• There has been a major blurring of roles
between deposit and non-deposit institutions:
• Banks can now offer investment services
• Non-banks now offer check writing and
savings
Financial Institutions (continued)
• What to Look for in a Financial Institution?
• Kinds of services provided
• What are your prioritized needs?
• Safety of your money
• How important is FDIC insurance?
• Cost of achieving your financial goals
• Which are most important now?
• Type of personal relationship provided
• Is this important?
• Note: You could use more than one financial
institution to take advantage of each one’s
strengths.
Financial Institutions (continued)
• Choosing a Financial Institution—the three Cs
• The Cost Factor
• Monthly fees, minimum balance, charge per
check, balance-dependent scaled fees
• The Convenience Factor
• Location (branches, ATMs), safety deposit
boxes, overdraft protection, stop-payment ability
• The Consideration Factor
• Personal attention, financial advice, attention to
detail
• Note that whatever institution you choose, it is your
responsibility to make sure they do what they say
they will
Questions
• Any questions on the different types of
financial institutions and how they can help
achieve your financial goals?
Review of Objectives
A. Do you understand the importance of good cash
management and how it can help you achieve your
goals?
B. Do you understand the different cash management
alternatives?
C. Are you convinced that while technology can help,
unless you plan and spend at least 1-2 hours a week
following your finances, you will not be able to keep
up with your financial goals?
D. Do you understand the different types of financial
institutions, and how they can help you meet your
financial goals?