Have you looked at the interest rate your school is earning on cash lately? Many of our schools hold a significant amount of cash, due to debt covenants or other reasons. In fact, our schools often maintain a liquidity ratio of six months or more. Your school can benefit from this cash by earning interest on it.
This type of cash is rarely within investment portfolios since it is considered emergency cash and cannot be put at risk. Therefore it’s up to business office staff to manage it prudently. Much of this cash is likely earning 0% interest when it could be earning much more, often 1% or more.
A mere 1% may not sound like much, but consider this example: 1% of $1 million is $10,000 per year, all of which could be used to enhance program and/or reduce stress on fundraising. Depending on the liquidity ratio and a school’s tuition rate, the amount could be equivalent to annual tuition from several students. From another viewpoint, it might cover the salary of a business office employee.
So what can a school do to obtain a higher interest rate on their cash?
Money Market Accounts
An easy step is to check what interest rate your bank is advertising for their money market accounts. This should be readily available on their website, or you can contact your banker for information.
Then, compare that information to the rates other banks are offering. Some banks looking to attract new customers will offer a rate that is higher than others; they strategically take less profit to acquire additional business. Your bank may not be able to match the interest rate of this type of competitor, but your banker should be willing to work with you to achieve an improved rate.
Large banks rarely offer high interest rates because they provide other benefits to customers such as physical locations, ATMs and in-person representatives. Smaller or online-only banks will often offer higher interest rates to attract additional deposits. Sometimes a school will find it effective to use a smaller bank for the majority of their banking needs and keep a small account at a larger bank for physical cash purposes.
Sweep accounts are a common way to automatically transfer excess funds from a checking account to a higher interest rate account daily. This takes advantage of higher interest rates at night and on the weekends when funds are not clearing. Your banker will be able to advise on what their sweep account rates are and if it would make sense for your school.
Certificates of Deposit
Often, certificates of deposit (CDs) will carry a higher interest rate than money market or sweep accounts because CDs cannot be drawn upon until they reach maturity. Also, the interest rate will be fixed for the period of time until maturity is reached. If you withdraw the funds before they mature, you lose the interest, but there is generally no other penalty or loss of funds. Thus, the funds can still be considered liquid.
CDs can be acquired in tranches, so the purchases can be spread over a period of months or quarters. This enables the CDs to mature at various times so funds become available regularly. This also has the benefit of not jeopardizing the entire amount of interest if you need to access a portion of the funds quickly. For example, rather than buying $1 million of 1-year CDs at the same time, with the result that all will reach maturity at the same time, you can buy $250,000 in the first quarter, $250,000 in the second quarter, and so on, so that after a year, 25% of funds would be mature and available. You can keep the cycle going so that a portion is always becoming available, or you can stop the cycle as you need the funds.
CDs are available in a variety of maturity periods, and banks will generally attach different interest rates to the periods based on their perception of market factors. In normal periods, CDs with a longer time horizon will generally have higher rates, but in times of volatility, CDs with a shorter time horizon may have a higher rate. Be aware, and compare and consider your needs.
At times, using all the methods of interest management at once will provide the best returns. All schools need a certain amount of cash to be always available. The amount will depend on your school’s risk tolerance and particular circumstances. It could be two months’ worth or it could be more. This cash would be in a checking account and might be swept into a sweep account for evenings and weekends. Due to debt requirements or management’s judgement, there may be about two months of additional funds that you would like liquid, but you do not actually intend to spend. This cash could be a great candidate for a money market account. Beyond this cash, you may be holding another several months’ worth of cash for a variety of reasons, such as maintaining flexibility while fundraising or stockpiling for a buying opportunity, and this cash could be a great candidate for CDs that mature in line with the time horizon of your projects. As mentioned above, if the time horizon is unknown, you could go the tranche route and invest in CDs in 25-30% chunks.
For example, if you need to hold $3 million in cash and decide to split it in $1 million chunks to take advantage of better interest rates, as of March 2023, you could earn about 1% on the $1 million in money market, about 4% on the $1 million in CDs, and 0% on the $1 million in checking, for an average interest rate of 1.67% on the $3 million, bringing in $50,000 annually for your school.
Treasury bills are backed by the U.S. government. Generally in the past their yield has been quite low, but with the current Federal Funds rate, the yield is attractive. These can be acquired directly using a Treasury.gov account, or your banker may be able to open a brokerage account for you within their current platform so that you have an easier time transferring funds back and forth. Like CDs, Treasury Bills must be held for a certain period to collect the full interest amount, but there is no risk to the initial investment if you decide to sell them before they mature.
Some other alternatives that we will not cover here but may be worth looking into further include: commercial paper, lending to your endowment, and using sweep or brokerage accounts to purchase CDs at other banks while staying within your current bank’s platform. Your banker will be able to advise on what options are currently available to your school, and other banks will also be willing to share what types of products they provide.
The 2022-2023 fiscal year has been interesting thus far, with the Federal Reserve (the Fed) continuing to raise interest rates. The expressed intention is to continue raising rates until inflation recedes. Investors are speculating whether the Fed will slowly or rapidly lower rates if indicators shift toward a recession. Banks are likely to lower interest rates more rapidly than the Fed does, and they are likely to lower them preemptively. Thus, consider carefully whether you want to keep money in floating-rate or fixed rate products, and when you want to buy fixed rate products.
If cash is not needed for a year or two, it seems advisable to acquire the highest-interest rate products when interest rates are the highest. No one can predict this, so again, it is prudent to split the acquisitions over several months, so that if you buy using 25-50% of your CD-allocated funds at a lower rate now and the rates increase, you can get 25-50% more at the higher rate. Conversely, if the market is already at the highest rate when you start buying, you may acquire 25-50% now at the highest rate and risk acquiring future tranches at a lower rate, but this method provides a better chance of maximizing the rates while the future is unknown.
Many bankers will advise to buy everything today, as they cannot guarantee that rates will be higher tomorrow. They are correct that they cannot guarantee high rates, but you have responsibility for the funds and the ability to research what the Fed is likely to do and also how markets are likely to react. Be sure to discuss your strategy with several trusted advisors, keeping in mind that your mission is to safely maximize the interest for the school while prudently ensuring that a flow of cash will be readily available for everything needed.