Where to Stash Cash and Earn A Decent Rate of Return
Although I believe it's important to be heavily invested in the stock market, I also believe it is important to keep some cash handy. I divide my cash holdings in to two piles. The first pile, which is the smaller of the two, is what I think I'll need day-to-day to cover things like credit card bills, rent, etc. This cash sits in a regular checking account. A checking account is key because it provides near instant access to my cash. However, the drawback with most checking accounts is that they don't pay much interest. In fact most checking accounts don't even keep up with inflation so you're actually losing money. As a result, it's best to keep the amount in checking accounts as small as possible.
The second pile of cash is readily accessible in the sense that I can get to it within 2-3 days via an electronic transfer request. This pile sits in a high-interest savings account where the interest rate is in the range of 4% to 4.5% interest at the time I wrote this post. That's a really good return for cash considering there is no risk (accounts are FDIC insured), minimums, or withdrawal restrictions. My three choices of banks with high-interest accounts are ING Direct, Emigrant Direct, and Citibank's new e-Savings account. At the moment, Emigrant Direct is offering 5.15% and Citibank is offering 5.0% while ING Direct is lagging at 4.35%. (Percentages were current on August 24, 2006.)
The one negative of both ING and EmigrantDirect is that they must be linked to a regular checking account. Citibank has the same restriction, but you're likely to have a checking account there already since they're a traditional financial institution. Money can go in to and come out of only this checking account which, as a side-effect, is a nice security feature. So if you need access to your money, you must place an online electronic transfer request and then wait for it clear. That delay is why I keep a small amount in a regular checking account.
Lastly, this second pile is mostly for surprises. That is, something unexpected happens that requires a fairly large cash outlay. In such situations, I wouldn't want to have to sell stock and incur capital gains taxes because I was caught short on the cash side. How much should you keep? That's a tough one to answer. What I did was come up with a few scenarios that were fairly plausible e.g. loss of employment and then determined what I needed to cover my expenses in the worst case e.g. no income for 6 months. There's no need to account for catastrophes such as meteors hitting the Earth since such things are too unlikely to worry about and, frankly, you're unlikely to come up with an effective plan to deal with the catastrophe.