One of the biggest frustrations for savers over the past year is the reduction in the amount of interest they are receiving in checking and savings accounts. While this is not a tremendous problem in and of itself, the recent concerns surrounding inflation exacerbate the problem when potential losses of purchasing power add to the equation. While setting aside cash for emergencies (generally 3-6 months of living expenses) and short-term expenses is a must, you should explore more efficient uses of excess cash in this environment to defend against the potential loss of purchasing power. While there are strategies that involve more risk, below are some options that appeal to the more conservative-minded:
Maximize Tax-Advantaged Accounts
A great first place to consider in this environment is to allocate excess cash in tax-deferred and tax-free accounts. Look to maximize tax deferment opportunities through company 401k plans and contribute to Traditional IRA’s and Roth IRA’s if you qualify. By contributing to tax-deferred accounts, you are guaranteed a tax deduction equal to your current marginal tax rate. By taking advantage of contributions to tax-free accounts like Roth IRAs, you are avoiding future tax altogether and adding flexibility in retirement when portfolio distributions begin.
Pay Down High Interest/Variable Rate Debt
Another great place to allocate excess cash is towards variable rates and other high interest rates with debt. With checking and other interest-bearing accounts offering near zero percent interest, eliminating debt on credit cards (which could be in the 17-20% range), student loans, and home mortgages is extremely appealing. The value here is the obvious reduction in debt and the potential improvement in credit scores, etc., which could lead to lower borrowing costs on future purchases.
Utilize Home Equity Lines of Credit
With the dramatic increase in home prices over the past several years, the opportunity to use home equity as a source liquidity has increased. One strategy I often recommend clients utilize is to establish a home equity line of credit through a local lending institution and then run a bit leaner on their cash to take advantage of opportunities like those mentioned above. For example, if one establishes an equity line for $25,000, maybe they can reduce their emergency cash reserve from $50,000 to $25,000 and utilize the extra cash towards more productive pursuits. The key here is to view the equity line as a liquidity preservation vehicle! **Warning**: DO NOT VIEW AS A LICENSE FOR GREATER CONSUMPTION!
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Marshall Clay CFP, J.D., is a Partner and Senior Advisor at The Welch Group, LLC, which specializes in providing Fee-Only investment management and financial advice to families throughout the United States. Marshall is a graduate of the United States Military Academy in West Point, New York, the Cumberland School of Law in Birmingham, Alabama, and is a CERTIFIED FINANCIAL PLANNER™. In addition, Marshall is a frequent guest on local television stations as an expert on various financial planning matters.
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