How Do You Compare Cash Management Alternatives To Determine Which Is Best For You?

Home > Intermediate Lessons > Cash Management > Understand the Different Cash Management Alternatives and How to Compare Them

When comparing cash management alternatives, it is critical to understand and accurately compare the following five areas.

You are watching: How do you compare cash management alternatives to determine which is best for you?

After-tax Return = Before-tax Return * (1 – Marginal Tax Rate)

Your marginal tax rate equals your federal marginal tax rate plus your state marginal tax rate (if any) plus your local tax rate (if any).

If any of the cash management assets have tax advantages, meaning they are either federal or state tax-free (or both), calculate the equivalent taxable yield (ETY). The ETY is the yield you would have to make on an equivalent taxable asset to give you the same after-tax return as the tax-advantaged asset. To calculate the ETY, first calculate the after-tax return of the tax-advantaged asset (i.e., a Treasury bill or I bond). Second, then divide that after-tax return by one minus your marginal tax rate (in other words, your marginal federal and marginal state tax rates).

ETY = After-tax Return/ (1 – Marginal Tax Rate)

To gain a better understanding of after-tax returns and equivalent taxable yields, see Learning Tool 26: After-tax, ETY, and After-inflation Returns in the Learning Tools directory of this website.

See more: 1405 County Route 22, Ghent, Ny Community Services, Directions To Art Omi

Real return = (1 + nominal return) / (1 + inflation) – 1

If inflation is a concern for you, there are inflation-linked bonds, such as US Government Series I bonds and Treasury Inflation-Protected Securities (TIPS), that take changes in inflation into account to determine yields.

Consider safety. Some investors consider all deposits at financial institutions to be safe. However, some banks and other financial institutions have historically made decisions that are not consistent with proper fiscal responsibility, and some investor deposits have been lost. FDIC and NCUA insurance are available for up to $100,000 per depositor (not per account). If your assets are greater than $100,000 and you want more insurance, deposit your assets in multiple federally insured institutions.

See more: Im T Pain You Know Me Lyrics T, Buy Ua Drank Lyrics

Although MMMFs are not insured, they may be invested in a diversified portfolio of government bonds; these bonds are guaranteed by the government. MMMFs may also be invested in short-term corporate bonds, which have very little risk. A certain degree of safety exists because of this broad diversification and because this debt is very short-term, often less than ninety days. So while there may be some concern for safety with MMMFs, it is not generally a major concern.

In summary, your choice of cash management asset depends on five areas. First, your goals and risk tolerance. What is the purpose for this money that you are investing? Second, the type of asset preferred. Are you investing in CDs, MMA, MMMF, or Savings bonds? Third, your tax situation. What is your marginal tax rate? Fourth, the location of the financial assets if they are municipal securities. Are they Muni’s from your state or from another state, and is there a state income tax from your state? And fifth, your use of the funds for savings bonds. Is the principle and interest used for tuition at a qualified school?

Licensed under a Creative Commons Attribution-Noncommercial-Share Alike 3.0 United States License.