Is Your Money Working as Hard as it Should?
By Brian Wheeler, Director of Wealth Management & Business Brokerage
Earning 4% on cash sounds pretty good. But what if taxes take 37% or more of that interest?
For someone in a high tax bracket, that can be the reality. And it’s a good example of why managing money involves much more than choosing good investments.
You may have plenty of cash, a diversified portfolio, an IRA or 401(k), a Roth account and money set aside for the future. On the surface, everything may look pretty good
But are those Pieces Actually Working Together?
You can own a collection of very good investments and still not have a particularly good investment strategy.
Cash Is Good. Too Much Cash Can Be Expensive.
Higher interest rates have been great for savers. After years of earning almost nothing at the bank, earning 4% or something close to it on cash feels pretty good. But how much of that 4% are you actually keeping?
For someone in a lower tax bracket, a 4% return on cash can be attractive. You get safety and liquidity and keep a larger percentage of the interest you earn.
For someone in the 37% federal tax bracket, that same 4% taxable yield is only about 2.52% after federal income tax. If the 3.8% Net Investment Income Tax also applies, you keep even less.
That doesn’t make cash bad. Cash has a job. The question is how much cash you need to do that job. Money you expect to need soon probably shouldn’t depend on what the stock market does next month. But once those needs are covered, it may make sense to ask whether some of the remaining cash could be working harder, and that doesn’t necessarily mean taking a lot more risk.
A conservative portfolio might combine cash or money market funds with U.S. Treasuries, municipal bonds and other high-quality fixed income, along with some dividend-paying stocks and international exposure for additional diversification.
For higher-income investors, municipal bonds may be especially worth considering because their interest can generally be exempt from federal income tax. Dividend income and potential appreciation may receive different tax treatment as well.
The point isn’t to chase a higher return. It’s to look beyond the advertised interest rate and ask: “What am I really earning after taxes, fees and inflation, and am I taking the right amount of risk to get there?”
Time Can Be One of Your Best Investments
Once we’ve covered the money you expect to need over the next two to four years, we can think differently about money invested for longer-term growth.
Markets go down. We know that. The bigger problem is being forced to sell growth investments while they’re down because you need the money.
If shorter-term needs are covered with more conservative investments, your growth portfolio may have something very valuable on its side: time to recover.
That’s why I like to think about giving different dollars different jobs. Some money is there for today, some for the next few years, and some may not be needed for 10, 20 or even 30 years.
They don’t all need to be invested the same way.
What You Own- and Where You Own It
The same idea applies to the accounts holding those investments.
Many investors have some combination of taxable accounts, traditional IRAs or 401(k)s, and Roth accounts. Because each is taxed differently, it may not make sense to own exactly the same investments in all of them.
Investments that generate significant taxable income might be better suited for a tax-deferred account. Investments with greater long-term growth potential may be attractive in a Roth, where qualified future withdrawals can potentially be tax-free. Other investments may fit well in a taxable account because of the treatment of qualified dividends or long-term capital gains.
There isn’t one formula that works for everyone. But what you own matters, and where you own it can matter too.
Fees deserve the same attention. The cheapest investment isn’t automatically the best investment, but you should understand what you’re paying and what you’re receiving for that cost. Even relatively small differences can become meaningful when applied to a sizable portfolio over many years.
Getting the Pieces to Work Together
At the end of the day, I don’t think good investment management starts with: “What should we buy?”
It starts with: “What do you need your money to do?”
How much should stay liquid? What needs to be protected over the next few years? What can be invested for longer-term growth? Are investments being held in the right types of accounts? Can we reduce unnecessary taxes and expenses without taking unnecessary risk?
That’s where thoughtful investment management can add value beyond simply selecting investments. It’s about coordinating your investments with your income needs, taxes, time horizon and the rest of your financial life.
Because the goal isn’t simply to own good investments.
It’s to make sure your money is working together—and that every dollar has a job.