L7 Financial Management

Personal Finance: Turning Money
into Wealth
Seventh Edition
Chapter 5
Cash or Liquid
Asset Management
Copyright © 2016, 2014, 2012 Pearson Education, Inc. All Rights Reserved.
Learning Objectives (1 of 2)
5.1 Manage your cash and understand why you need
liquid assets.
5.2 Automate your savings.
5.3 Choose from among the different types of financial
institutions that provide cash management services.
5.4 Compare the various cash management alternatives.
Learning Objectives (2 of 2)
5.5 Compare rates on the different liquid investment
alternatives.
5.6 Establish and use a checking account.
5.7 Transfer funds electronically and understand how
electronic funds transfers (EFTs) work.
Introduction
• Liquid assets are a necessity of personal financial
management.
• Without liquid funds, you might have to compromise your
long-term investments to cover unexpected expenses.
• You could ruin your financial plan if you don’t manage
liquid funds effectively.
Managing Liquid Assets
• Cash management—the management of cash and near
cash (liquid) assets.
• Making choices from among alternatives, maintaining and
managing the results of those choices.
• Liquid assets—cash and investments that can easily be
converted into cash.
• Low risk and low return but the more cash your have, the
more you’re tempted to spend.
Automating Savings: Pay Yourself
First
• Have savings automatically deducted from your paycheck
—pay yourself first.
• Automatic savings are not in liquid reservoir therefore
less likely to spend that money.
• The earlier you start to save, the easier it is to achieve
your goals—time value of money.
Financial Institutions (1 of 2)
• “Banks” or Deposit-type financial institutions—Financial
institutions that provide traditional checking and savings
accounts
• Commercial banks, credit unions, savings banks, etc.
Table 5.1 “Banks” or Deposit-Type
Financial Institutions
Commercial Banks These offer the widest variety of financial services, including checking and savings
accounts, credit cards, safety-deposit boxes, financial consulting, and all types of
lending services. They also dominate in terms of the dollar value of the assets they
hold, and they have more branch offices or locations than any other type of financial
institution. They also tend to have neighborhood locations, which allow for personal
relationships.
Savings and Loan Originally established to provide mortgage loans to depositors; today, services offered
Associations (S&Ls by S&Ls and commercial banks have become very similar, with both offering almost
or “thrifts”) identical savings alternatives. However, S&L accounts often earn one-quarter percent
more than savings accounts at competing commercial banks.
Savings Banks Savings banks are close cousins to savings and loan associations and are generally
found in the northeastern United States. Their primary purpose historically has been to
provide mortgage funding to their depositors.
Credit Unions Credit unions are established by a wide variety of organizations such as churches,
universities, trade unions, and corporations. They are open only to members of that
organization and are quite similar to commercial banks and S&Ls. Because of their tax-
exempt status as not-for-profit organizations, they are generally more efficient, often
pay higher interest rates, have lower fees, and have more favorable loan rates than
commercial banks.
Financial Institutions (2 of 2)
• Nondeposit-type financial institutions—mutual fund
companies, brokerage firms, insurance companies
offer similar services as those offered by banks.
Table 5.2 Nondeposit-Type Financial
Institutions
Mutual Funds A mutual fund is an investment fund that raises money from investors,
pools that money, and invests it in a collection of stocks and/or bonds that
is managed by a professional investment manager. Mutual funds earn
dividends on stocks and interest on bonds, and they pay out this income to
the fund owners in distributions.
Stockbrokerage Firms Stockbrokerage firms that have traditionally dealt only with investments
such as stocks (hence, their name) have recently introduced a wide
variety of cash management tools, including financial counseling, credit
cards, and their own money market mutual funds (which we'll talk about
later). In effect, they've entered into direct competition with traditional
banks.
Online Banking
• Access to your accounts to:
– check balances,
– transfer funds,
– paying bills, and
– view your financial information
– through the internet, a mobile phone, or other
electronic device.
• Allows you to choose an internet-only bank.
Table 5.3 Online and Mobile Banking
Advantages of Online and Mobile Banking
• Personal financial management support: You can import data into a personal finance program such as
Mini.com, Quicken, or TurboTax.
• Convenience: You can view and track your accounts, pay bills, and view up-to-the minute credit card activity
anytime, from anywhere.
• Efficiency: You can access and manage all of your bank accounts, including IRAs, CDs, and even securities,
from one secure site and transfer funds between your checking and savings accounts or to another
customer‘s account.
• Effectiveness: Many online and mobile banking sites provide stock quotes, rate alerts, and personal
financial management support that allows you to import data into a personal finance program such as
Mint.com.
Disadvantages of Online and Mobile Banking
• Start-up time: It takes time and some effort to register for your bank's online and mobile program. If you are
setting up an account together with a spouse, you may have to sign a durable power of attorney before the
bank will display all of your holdings together.
• Adapting to online and mobile banking: Banking sites can be difficult to navigate at first, so expect to
spend some time working through the tutorial. In addition, these sites periodically change, which may require
reentering data.
• Feeling comfortable: Many people just don't feel comfortable banking online, and regardless of how
comfortable you feel, you should always print the transaction receipt and keep it with your bank records until
it shows up on your bank statement.
• Customer service: The potential for poor customer service is a downside to online and mobile banking.
What to Look For in a Financial
Institution
• Which financial institution offers the kind of services
you want and need?
• Is your investment safe? Is your investment insured?
Is the financial institution sound?
• What are all the costs and returns associated with
the services you want? Are there minimum deposit
requirements or hidden fees?
Cash Management Alternatives (1 of 8)
Checking Accounts
• Advantages:
– Liquid, Safe, Low minimum balance, Convenient
• Non-interest bearing—demand deposits
• Interest bearing—NOW accounts
– Disadvantages: minimum balance required, monthly
fee, opportunity cost, interest less than alternatives
Savings Accounts
• Advantages:
– Liquid
– Safe—federally insured
– Earns higher interest than a Checking Account
• Disadvantages
– Minimum holding time
– Charges/fees
– Low interest rate
– inconvenient
Money Market Deposit Account (MMDA) —alternative
to savings account, variable interest rates, check and
ATM access.
• Advantages:
– Safe, Earns interest, Check writing privileges
• Disadvantages:
– High minimum balances/penalties, interest rates
below alternatives
Certificates of Deposit (CD)—pays a fixed rate of interest
while funds are on deposit for a period of time (30 days to
years).
• Advantages:
– Safe, fixed interest rate, convenient.
• Disadvantages:
– Early withdrawal penalty, fixed interest rate, minimum
deposit required.
Money Market Mutual Funds (MMMF’s)—investors
receive interest on a pool of investments less an
administrative (usually less than 1% of total investment)
• Advantages:
– High interest rates, check writing, limited risk,
convenient.
• Disadvantages:
– Administrative fees, minimum initial investment,
not insured, minimum checks.
Asset Management Account—a comprehensive financial
services package (checking account, credit card, MMFs,
etc.) offered by a brokerage firm.
• Advantages:
– Monthly statements, coordination of money
management, checks, high return, convenient.
• Disadvantages:
– Costly, minimum initial investment, not insured.
U.S. Treasury bills, or T-bills—short-term debt issued by
the federal government with maturities from 3-12 months.
• Advantages:
– Risk-free, exempt from state and local taxes, federal
tax vary with current rates.
• Disadvantages:
– Low rate of return
U.S. Savings Bonds—Series EE and I bonds are safe, low
risk savings products issued by the Treasury with low
denominations.
• Advantages:
– Safe, affordable, no taxes, convenient, redeem at any
bank, no commissions or fees.
• Disadvantages:
– Low liquidity, long maturity, semi-annual compounding.
Comparing Cash Management
Alternatives
• Comparable Interest Rates—use the annual percentage
yield (APY) to easily compare.
• Tax Considerations—taxes affect the real rate of return
on investments.
• Safety—some deposits are federally insured
– FDIC deposits at commercial banks
– NCUA deposits at credit unions
– MMMF—not insured but diversified
Table 5.4 Different Cash Management
Alternatives (1 of 2)
Cash Management Advantages Disadvantages
Technique
Checking or Demand Liquid Minimum balance required
Deposit Account Safe—federally insured Monthly fee
Low minimum balance Opportunity cost
Convenient Pays less than some other alternatives
for your money
Savings or Time Deposit Liquid Minimum holding time and/or balance
Account Safe—federally insured Charges/fees
Earns higher interest than a checking account Low interest rate
Money Market Deposit Safe—federally insured High minimum balance/penalties
Account Earns interest Interest rates below alternatives
Check-writing privileges
Certificate of Deposit Safe—federally insured Penalty for early withdrawal
(CD) Fixed interest rate (beneficial if interest rates Fixed interest rate (bad if interest rates
drop) rise)
Convenient—buy through payroll deduction Minimum deposit required
plan
Money Market Mutual Relatively high interest rates Administrative fees
Fund Check-writing privileges Minimum initial investment
Limited risk due to short maturity of investments Not federally insured
Convenient—buy through payroll deduction Minimum check amount (maybe)
plan
Table 5.4 Different Cash Management
Alternatives (2 of 2)
Cash Management Advantages Disadvantages
Technique
Asset Management Monthly summary statements Costly—monthly/quarterly fees and
Account Automatic coordination of money management commissions
Unlimited check writing Minimum initial investment
Relatively high return Not federally insured
U.S. Treasury Bills, or T- Risk-free—issued by the U.S. Treasury Low rate of return because they are
Bills Exempt from state and local taxes risk free
Federal taxes vary with current rates
U.S. Savings Bonds Safe—issued by the U.S. Treasury Low liquidity—must hold for 12
Affordable—available in low denominations months; penalty
Taxes—no state or local taxes; exempt from if redeemed before 5 years
federal taxes if used for education Long maturity
Convenient—buy through payroll deduction Interest compounds only semiannually
plan, online, or at most financial institutions Limits on how many you can buy per
Redeem at any bank year
No sales commissions or fees Other investments may earn more
Establishing and Using a Checking
Account
• Choosing a financial institution, consider:
– Cost
– Convenience
– Consideration
– Safety
• Balancing your checking account:
– Keep track of every transaction
– Compare monthly statement with register, then
reconcile register balance with bank balance.
Checklist 5.1 The Three Cs of
Choosing a Financial Institution
Cost Consideration
• Fees • Personal attention provided
• Rates • Financial advice that you are
• Minimum balances comfortable accessing
• Per-check charges Safety—The Final Consideration
Convenience • Federal deposit insurance
• Location
• Access to ATMs
• Availability of safety-deposit boxes
• Availability of direct deposit services
• Availability of overdraft protection
Table 5.5 Overdraft Protection and New
Rules for Debit and ATM Cards (1 of 2)
Overdraft Protection Generally, banks can cover your overdrafts in one of two ways.
• Standard overdraft practices. Your bank will cover your transaction
for a flat fee of about $20–30 each time you overdraw your
account. For example, if you make a purchase with your debit card
for $150 but have only $100 in your account, your account will be
overdrawn by $50, and your bank will charge you a fee. If you then
make an ATM withdrawal for $50, your account will be overdrawn by
$100, and you will be charged another fee. In this example, if the fee
your bank charges for its standard overdraft practices is $30, you will
pay a total of $60 in fees.
• Overdraft protection plans. Your bank may offer a line of credit, a
credit card, or a link to your savings account to cover transactions
when you overdraw your account. Banks typically charge a fee each
time you overdraw your account, but these overdraft protection plans
may be less expensive than their standard overdraft practices.
Table 5.5 Overdraft Protection and New
Rules for Debit and ATM Cards (2 of 2)
Rules for Debit and One of the changes that came out of the recent financial crisis deals with new
ATM Overdrafts rules for debit and ATM card overdrafts.
• You choose. In the past, some banks automatically enrolled you in their standard
overdraft practices for all types of transactions when you opened an account.
Under the new rules, your bank must first get your permission to apply its
standard overdraft practices to everyday debit card and ATM transactions
before you can be charged overdraft fees. To grant this permission, you will
need to respond to the notice and opt in (agree).
• Existing accounts. If you do not opt in (agree), your bank's standard overdraft
practices won't apply to your everyday debit card and ATM transactions. These
transactions typically will be declined when you don't have enough money in your
account, but you will not be charged overdraft fees.
• New accounts. If you open a new account, your bank cannot charge you
overdraft fees for everyday debit card and ATM transactions unless you opt in.
• Flexibility. Whatever your decision, the new overdraft rules give you flexibility. If
you opt in, you can cancel at any time. If you do not opt in, you can do so later.
• Checks and automatic bill payments. The new rules do not cover checks or
automatic bill payments that you may have set up for paying bills such as
your mortgage, rent, or utilities. Your bank may still automatically enroll you in
their standard overdraft practices for these types of transactions. If you do not
want your bank‘s standard overdraft practices in these instances, talk to your
bank; you may or may not have the option to cancel.
Figure 5.1 Worksheet for Balancing
Your Checking Account
Figure 5.2 Balancing Your Checking
Account
Other Types of Checks
• Cashier’s Check
• Certified Check
• Money Order
• Traveler’s Checks
Electronic Funds Transfer (EFT) (1 of 2)
• Any financial transaction that takes place electronically.
• Advantages:
– Transactions take place immediately.
– Don’t have to carry cash or write a check.
– Pay all kinds of bills
Electronic Funds Transfer (EFT) (2 of 2)
• Examples:
– ATM transactions
– Debit card transactions
– Smart cards
– Stored Value Cards
Automated Teller Machines
• Provide cash instantly and accessed through a credit or
debit card.
• Convenient but can be costly.
• Banks charge access fee. Using ATM not owned by your
bank can cost $5 per transaction.
• Attract crime.
Checklist 5.2 ATM Security
Keep Your Card Secure
• Treat your ATM card like cash. Always keep your card in a safe place.
• Keep your PIN a secret. Memorize your code. Never write it on your card or store it with the card.
Never tell your code to anyone. And never let someone else enter your code for you.
• Report a lost or stolen card at once.
• Check your receipts against your monthly statement to guard against ATM fraud.
Security at ATMs
• Always observe your surroundings before conducting an ATM transaction.
• If an ATM is obstructed from view or poorly lit, go to another ATM.
• If you are using a walk-up ATM, take a companion along if possible—especially at night.
• Minimize time spent at the ATM by having your card out and ready to use.
• If you see anyone or anything suspicious while conducting a transaction, cancel your transaction
and leave.
• If you are followed after making an ATM transaction, go immediately to a heavily populated, well-
lighted area and call the police.
• If you are at a drive-up ATM, keep your engine running, the doors locked, and the windows up at
all times when waiting in line. Before rolling down the windows to use the ATM, check the entire
area for anything or anyone suspicious.
Debit Cards
• Allow you access to money in your accounts electronically.
• Looks like a credit card but acts like a checking account.
• ATM card is type of debit card but with access to savings
accounts.
• Check card blocking policies.
Smart Cards
• Funds are transferred into cards which are used like debit
cards, but withdraw from an account that’s actually stored
magnetically on the card.
• Perform the same services as a debit or credit card.
• Allocated funds can run out.
• Some have issuer-limited usage.
Prepaid Debit or Gift Cards
• Two main types:
– Single purpose or “closed-loop” cards which can be
used at only one store.
– Multi-purpose or “open-loop” cards which can be used
just like a credit card and can be reloaded.
• Many have activation fees, maintenance fees, and ATM
transaction fees
Fixing Mistakes—Theirs, Not Yours
• Human and computer errors.
• Avoid human errors such as those involved with deposits
at ATMs.
• Report immediately. Call or write the bank.
• By law, write within 60 days of receiving your statement.
Summary (1 of 2)
• Cash management is balancing the risk of not having
enough in liquid assets with the potential for greater
return on other investments.
• Automatically save some of your income and learn to
live on take-home income.
• Choose cash management alternatives from among
deposit-type and nondeposit-type institutions.
Summary (2 of 2)
• Compare various cash management alternatives.
• Compare their rates, return, and safety.
• With checking accounts look into cost, convenience,
consideration, and safety.
• Electronic funds transfer transactions occur immediately
and avoid use of cash or check.
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