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Cash management refers to how you manage your cash and liquid assets. Liquid assets allow you to invest your money and earn an acceptable return while at the same time keeping your assets available to pay bills or cover emergencies. While liquid assets are low-risk and are great for emergency funds, their return is generally very low. The challenge of cash management is to balance the risk of lower returns with the need for liquidity.

Good cash management is important because it will help you earn more income on your liquid assets; in this way, cash management can help you achieve your personal goals. There are three main trade-offs regarding cash management. The first is the risk-return trade-off: higher liquidity means lower returns. Generally speaking, the more liquid the financial asset, the lower the return you can expect to receive on that asset. The second trade-off is the spending/investment risk: cash on hand is easier to spend than other financial assets. Nonliquid financial assets generally require time and effort to convert to cash. The third trade-off is the return/time expended risk: since returns are smaller with existing liquid assets, the time you spend on managing those assets should be much less than the time you spend managing other types of financial assets. In spite of these three trade-offs, you can still influence your portfolio in a positive and significant way by using your liquidity wisely.

Traditional cash management alternatives include checking accounts and savings accounts. Less traditional, but important, alternatives include money market deposit accounts, certificates of deposit, money market mutual funds, asset management accounts, U.S. Treasury bills, U.S. Series EE bonds, and U.S. Series I bonds. While rates for each of these assets can change from day to day, you can find current rates at major financial Internet sites and in the pages of most financial newspapers, such as the Wall Street Journal.

When you are comparing cash management alternatives, it is critical to accurately evaluate four areas. First, use a consistent method of comparing interest rates. Certain cash management assets are compounded annually, others are compounded quarterly, and still others are compounded daily. Use a consistent method of comparing interest rates when considering cash management alternatives.

Second, use a consistent method of comparing after-tax returns. While certain assets may have lower returns, these same assets are often exempt from state and local taxes, and they may be exempt from federal taxes if the assets are used for college tuition. Consider tax advantages and after-tax returns.

If the assets have tax advantages, in other words if they are either federal or state tax-free (or both), calculate the equivalent taxable yield; the taxable yield is the yield is the yield you would have to make on a taxable asset to give you the same after-tax return as the tax-advantaged asset.

Third, consider inflation. Remember, it is not what you earn but what you keep after taxes and inflation that makes you wealthy. Calculate the “real return” of each of your assets. The real return is calculated by the following equation:

Real return = (1 + nominal return) / (1 + inflation) – 1

If the assets have tax advantages, in other words if they are either federal or state tax-free (or both), calculate the equivalent taxable yield; the taxable yield is the yield you would have to make on a taxable asset to give you the same after-tax return as the tax-advantaged asset.

Fourth, consider safety. FDIC and NCUA insurance are available for amounts up to $100,000 per depositor (not per account). If your assets are greater than $100,000 and you want more insurance, deposit your assets in multiple federally insured institutions.

We concluded by discussing different types of financial institutions that offer the various types of cash management alternatives. The distinction is gradually blurring between which services are offered by traditional banks and which services are reserved for other non-bank institutions

There are two major types of financial institutions: banks, (deposit-type financial institutions) and nonbanks (non-deposit-type financial institutions). Which institution you use depends on which will serve your needs the best and which will help you achieve your goals the fastest.

Deposit-type financial institutions generally fit into four categories: commercial banks, savings and loan associations, credit unions, and the newer Internet banks. There are two main types of nonbank financial institutions: mutual fund companies and brokerage firms.


Now that you have completed this section, ask yourself the following questions:

  1. Do you realize the importance of good cash management and understand how it can help you achieve your financial goals?
  2. Do you understand the different cash management alternatives?
  3. Do you know the different types of financial institutions and understand how they can help you meet your financial goals; do you know which ones will pay you the most on your liquid savings?
  4. Do you understand that while technology can help you, you may not be able to keep up with your financial goals unless you plan and spend at least one to two hours per week following your finances?


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