Investing Excess Cash: Strategies For Maximizing Your Returns

If you have excess cash, there are several options to consider. You could put it into a savings account, invest it, or pay off any existing debt. If you choose to invest, you could use a brokerage account, increase contributions to a 401(k), 403(b), or IRA, or invest in stocks, bonds, or mutual funds. You could also use the money to pay off student loans or refinance your mortgage.

Pay off high-interest debt

If you have excess cash, one option is to pay off any high-interest debt you have. This is a good idea because it will save you money in the long run. The longer you have high-interest debt, the more money you will pay in interest.

To pay off high-interest debt, you should first list all your debts, along with the minimum monthly payments, outstanding balance and estimated payoff date. Then, ask yourself the following questions:

• Which of these debts is impacting my budget the most?
• What would my monthly budget look like if I didn't have this debt anymore?
• Will paying off this debt make more of a difference in my life than paying off these others?
• How much extra can I realistically put toward debt repayment without risking my budget?
• Is there a debt that is small enough to be paid off quickly?

Once you have a clear picture of your debt, you can employ the "high-interest first" strategy, also known as the "debt avalanche method". This involves making the minimum monthly payments on all of your debts, but putting any extra money you can towards the debt with the highest interest rate. This is a smart move because you're tackling the costliest debt first.

However, this strategy might not be the best option for everyone. If you have multiple accounts with similar interest rates, or if you have a large balance on a high-interest debt, it could take a while to pay it down, which may be discouraging. In this case, you could consider the "smallest debt first" strategy, also known as the "debt snowball method". This involves making the minimum monthly payments on all of your debts, but putting any extra money towards the smallest debt first. The advantage of this method is that it can help build motivation and encourage you to stick with the plan, as you will experience quick wins along the way.

Invest in a brokerage account

Investing excess cash in a brokerage account is a popular type of non-retirement investment account. There are no income restrictions or funding limits, and a taxable account provides the most options for investing extra money. Unlike retirement accounts, you can use the assets in a brokerage account for any purpose at any time without incurring early withdrawal penalties.

A brokerage account is funded with after-tax dollars, like savings in your bank account. The account is also subject to tax annually for dividends, interest, or capital gains distributions from mutual funds and ETFs received during the year, even if you did not sell an investment and reinvested the proceeds. When you sell a fund in your account, there will usually be a taxable capital gain or loss depending on your purchase price and cost basis, which will be taxable in the current year.

A brokerage account offers many other benefits, including tax planning opportunities in retirement, funding an early retirement, paying for college, and even leaving an inheritance with tax benefits.

• Let go of the past: If you feel you have missed out on past market gains, you are not alone. One of the top investing regrets of Americans is not investing more aggressively. However, it is important to focus on the future and not get stuck on regrets about missed opportunities.
• Focus on the future: While you cannot capture past gains, you still have the chance to benefit from future ones. Historically, the stock market has risen over the long term, and investing in stocks and bonds has provided better growth than cash over extended periods.
• Figure out your risk tolerance: In investing, risk is often thought of in terms of how much an investment may rise or fall in price. Your risk tolerance may depend on factors such as how far away your investment goal is, how comfortable you feel with potential dips in your portfolio's value, and your financial situation.
• Determine your asset allocation: Also known as your big-picture investment mix, this refers to the overall mix of stocks, bonds, cash, and other investments in your portfolio. Your asset allocation should generally align with your risk tolerance and other factors. A higher risk tolerance may allow you to hold more investments with higher risk and higher return potential, such as stocks.
• Consider specific investments: You will need to pick individual investments to fill out your asset allocation, such as mutual funds, exchange-traded funds (ETFs), individual stocks, and bonds. While the number of options can be overwhelming, you can focus on building a diversified mix of investment types and sectors.
• Pick a pace for investing: Once you know what your ideal portfolio looks like, you can choose to invest a lump sum all at once or buy in gradually over time with consistent, smaller purchases. Investing a lump sum provides more time in the market and the potential for higher returns, but spreading out your investments may be more comfortable for you.
• Don't get stuck on timing: It is more important to focus on your end goal of getting invested rather than trying to time the market perfectly. Missing out on only a few days of market gains can impact your portfolio's long-term returns, and investing during downturns has historically provided some of the best subsequent returns.

Increase contributions to a 401(k), 403(b), or IRA

If you're looking to invest excess cash, one option is to increase contributions to a 401(k), 403(b), or IRA. These are all tax-advantaged retirement savings accounts that can help you build financial security for the future. Here's what you need to know about each:

K)

A 401(k) is a retirement plan offered by private companies to their employees. It allows for a diverse range of investments, including individual stocks, bonds, annuities, exchange-traded funds (ETFs), mutual funds, and target-date funds. The maximum contribution limit for 401(k)s in 2024 is $23,000 per year, and if you're aged 50 or older, you can make a catch-up contribution of an additional $7,500. It's important to note that you may only contribute up to a certain percentage of your eligible compensation, as defined by the plan terms. Additionally, 401(k) plans often come with generous employer matches, which can boost your savings further.

B)

A 403(b) plan is similar to a 401(k) but is typically offered to employees of non-profits, public schools, tax-exempt organizations, and religious groups. It offers a more limited range of investments, including mutual funds and annuities. The contribution limits for 403(b) plans are the same as for 401(k)s: $23,000 in 2024, with a catch-up contribution of $7,500 for those aged 50 or older. 403(b) plans have fewer administrative requirements than 401(k)s and are often administered by insurance companies.

IRA (Individual Retirement Account)

An IRA is a tax-advantaged retirement savings account that individuals can set up on their own. The annual maximum contribution for a traditional or Roth IRA is $7,000 in 2024, and you can make a catch-up contribution of up to $1,000 if you're aged 50 or older. IRAs offer a variety of investment options, and you can choose to make contributions with pre-tax or after-tax dollars.

When deciding how much to contribute to these accounts, it's recommended to save between 10% and 15% of your income towards retirement. This may vary depending on your age and other factors, so it's always a good idea to consult with a financial professional to determine the best strategy for your personal situation.

Invest in a money market fund

Money market funds are a type of mutual fund that invests in cash, cash equivalents, and short-term debt securities. They are designed to offer portfolio diversification, liquidity, and operational ease. Money market funds are not guaranteed or insured, and you could lose money by investing in them. However, they are regulated by the Securities and Exchange Commission (SEC) and are required to invest in low-risk, short-term debt securities.

Money market funds are an alternative to traditional savings accounts. They are a relatively safe place to hold money that you don't need immediately, such as an emergency fund or cash reserves. Money market funds offer liquidity, which makes them a good option for investors who want quick access to their money. Unlike money market accounts, which are deposit accounts that pay interest on your balance, money market funds are an investment product. As such, they are not protected by deposit insurance. However, they can be a good option when interest rates are high.

There are several types of money market funds, including government, municipal, and prime money funds. Each type invests in a specific debt instrument, which determines the fund's risk level, yields, and maturity period. Government money market funds, for example, invest in cash, government securities, and fully collateralized repurchase agreements, making them one of the safest options. Municipal money market funds invest in short-term debt issued by state and local governments, and earnings may be exempt from federal and state income taxes. Prime money market funds invest in a variety of short-term, high-quality debt securities, including certificates of deposit, corporate notes, and commercial paper.

When deciding whether to invest in a money market fund, consider your financial goals, risk tolerance, and investment horizon. Money market funds are suitable for those seeking a short-term, low-risk investment with high liquidity. They are also a good option for those who want to earn a higher return than a traditional savings account while maintaining liquidity. However, keep in mind that money market funds have operating and administrative costs, which are passed on to investors as expense ratios, and these can eat into your returns.

To invest in a money market fund, you will need to open a brokerage account with an online trading platform or investment app. Most brokers will ask for personal information such as your social security number and annual income. You will then need to determine how much you want to invest, considering your short-term investment goals, risk tolerance, and financial circumstances. Finally, choose a money market fund that aligns with your goals and risk tolerance, comparing features such as expense ratios, minimum investment requirements, and interest rates.

Before investing in a money market fund, it is important to understand the potential risks and drawbacks. While money market funds are considered low-risk, they are not FDIC-insured, and there is a chance you could lose money. Additionally, the returns may not be high enough to outpace inflation or build wealth over time, making them unsuitable for long-term savings goals. Finally, keep an eye on the expense ratios, as fees can eat into your returns.

Invest in yourself

Investing in yourself is a great way to use your excess cash. This could mean improving your financial literacy, developing new skills, or taking care of your health. Here are some ways to invest in yourself:

• Financial Education: Consider investing in your financial knowledge by seeking advice from a financial advisor or planner. They can help you make informed decisions about your money, including how to invest it wisely and avoid costly mistakes. You could also consider taking online courses or reading books on personal finance and investing to improve your financial literacy.
• Education and Skill Development: Invest in your personal growth and career development by enrolling in courses, workshops, or training programs. This could help you gain new skills, advance your career, and potentially increase your earning power. You could also use your excess cash to fund further education, such as a degree or certification, which could open doors to new career opportunities.
• Health and Wellbeing: Investing in your health is another way to invest in yourself. Consider using your excess cash to join a gym or health club, or to invest in home exercise equipment. You could also use it to improve your diet by purchasing healthier foods or investing in meal delivery services that provide nutritious meals. Additionally, you could allocate some of your excess cash to fund stress-relieving activities like yoga, meditation, or other wellness practices that promote a healthy work-life balance.
• Time: Investing in yourself can also mean freeing up your time. Consider hiring help for tasks that you don't enjoy or that take up a lot of your time, such as cleaning or yard work. This will give you more time to focus on your passions, hobbies, or side hustles that could potentially generate additional income.

Remember, investing in yourself can have a significant impact on your overall well-being and long-term success. It can help you develop new skills, improve your financial literacy, enhance your career prospects, and promote a healthier lifestyle.

Frequently asked questions