Murphy’s Law: What can go wrong, will go wrong.
O’Toole’s commentary: Murphy was an optimist.

Rule 3 Don’t Be Caught Empty-Handed: Cash Reserves and insurance

After a short section on why you need cash reserves, this chapter focuses options for where to put the cash, and then concludes for some words on insurance, with a focus on life insurance.

In the chapter, Malkiel provides a helpful overview of the options where your money will be safe, readily assessable and still earn a little return (unfortunately in our day, the return is a very little).

Establishing a Cash Reserve

Many investment advisers say “Cash is trash” as you don’t make much return on it. Yet everyone needs some reserves in safe, liquid investments for life’s surprises, as bad things happened to good people. In addition, you should be fund expected large, future expenditures (college for kids, etc) with short-term investments (e.g. bank CDs) whose maturity matches the date when needed.  Here is a look at his alternatives (and at the very end, what we are using at this writing).

Money-Market Mutual Funds

He believes this is the best instrument for cash reserves. They are safe and have “relatively generous yields” [at his writing of 2003 he was saying 1-5%; at this time (2011) do not expect much].

His list of low-expense money market funds (at the time) included:

• Fidelity’s Spartan Money Market Fund – https://www.fidelity.com/
• TIAA-CREF Money Market fund – https://www.tiaa-cref.org
• USAA money mark fund – https://www.usaa.com
• Vanguard money market – http://vanguard.com/

Minimum purchases listed in his book are $ 2,500 to $20,000.

Below (under CDs), he suggests you go to www.bankrate.com to look at rates. They have them for money market accounts as well. As of 3/27/11, it appears the best rate with no minimum is 1.2%; with several options between 1% to 1.2%.

[Again, see the bottom of the article for what we are using.]

Bank Certificates of Deposit (CDs)

You get these through a bank. They require you to tie up your money for a period of time but can have higher yields (although not much today). Interest earned is subject to taxes.

He suggests you go to www.bankrate.com to look at rates. Best rates as of 3/27/11.

1 year: 1.25%
2 year: 1.5%
3 year: 1.75%

Internet Banks

You can find them included in bankrate.com above. [I think our choice below, ING, is in this category; although it does not show up on bankrate.com.]

Treasury Bills

Know as T-bills. These are backed by the federal government. They have maturities of 4 weeks, 3 months, 6 months, one-year. He says all but the 4-weeks are purchased directly from the government. Earnings are exempt from state and local taxes.

Go to http://treasurydirect.gov/ to purchase. It looks like they are currently (March 2011) paying well under 0.5 % for the shorter term bills.

Tax-exempt Money-Market Funds

See the book for more (as I do not have to worry about this).

Buying Insurance

He says that one is negligent if one does not purchase insurance: auto, home owners, medical, and life insurance. He also recommends disability insurance (which I do not carry, not a bad idea; I built up my sick leave as my disability insurance).

Most of his discussion is on the difference in term and whole life insurance, recommending term (and investing the difference according to the principles in the book).

For term he suggests you consider:

• Renewable term. He says decreasing term will work best for most families with an investment plan as you insurance needs will diminish over time (and as premium rise over time).
• Or level-premium insurance to cover extended period of insurance needs (I have some of this).

For term insurance rates, see http://term4sale.com/. He recommends buying from a firm with no less than an A rating with AM Best.

Variable Annuities

This is another life insurance vehicle, which he recommends avoiding, that combines insurance and investment. He thinks you can do better by getting insurance separate from investing. But if you wish to buy such, he suggests buying directly from TIAA-CREF or Vanguard rather than through an agent.

What we do for our cash funds (including our emergency fund): ING Orange Savings Account. Paying 1% (3/27/2011). They advertise: “No minimum, no fees, no catches”. This has been the case with us. http://home.ingdirect.com/index.html. You open an on-line account and link it to your checking. Then you can transfer money easily from one to the other. We have 8 of them: emergency fund, home improvement, college (almost done!), weddings (one more to go), car purchase/maintain/repair, property tax/propane, vacation, special giving. 6 of the funds get monthly transfers from our checking account, 2 of them get influxes twice a year when I get three paychecks in a month.  I pull from them as needed. It takes about 3 days.

What we do for expected large, future expenditures – Much of this money is in our INGs above.  But based on advice from our financial counselor: we have also been using an account with https://www.ftjfundchoice.com/, their Litman/Gregory Capital Preservation Fund. I am not sure what all is in the fund but it has been returning about 4 – 5% per year. The value does drop some when the DOW goes down but not much. Returns have been good enough for me to keep there. You may have to use an advisor to set this up.

Next time: Stiff the tax collector

The above is from my on-going study on investing, from Malkiel’s  The Random Walk Guide on Investing. For more, see the index page to my full summary.