Liquidity or High Returns?

Phil and Kendra Gonzalez both work for the same high-tech company as software designers, and their combined take-home pay is \($5,200\) per month. With monthly expenses that average only \($3,000\), they’ve been able to accumulate \($14,000\) over the past year in a joint savings account that pays 3 percent interest.

They also generally keep a little more than their \($500\) minimum balance in a checking account that pays no interest. If their checking account drops below the

\($500\) minimum in any given month, the bank assesses a monthly fee of \($10\). This happens to them about once every three months.

Phil and Kendra have no investment accounts other than their savings account and their employment based retirement funds. Phil is trying to talk Kendra into putting \($5,000\) of their savings into a higher-interest CD and another \($5,000\) into a stock mutual fund. He has found an online bank that is offering 6 percent interest on five-year CDs, and he has been investigating several stock funds. Kendra is not so sure. To investigate, she asks their current bank about cash management account alternatives that might provide them with better interest earnings. The bank officer suggests that they consider moving their checking to an interest-earning account that pays 2 percent per year and carries a

\($1,000\) minimum balance. He suggests spreading their investments into several CDs with increasing maturities.

The five-year CD at this institution pays 5.75 percent.

1. How much do you think the Gonzalez's should hold in liquid accounts? Explain your reasoning.

2. What are the risks of putting the money in CDs or in stocks instead of keeping it in regular savings?

3. Are Kendra and Phil exposed to any unusual liquidity risks because they work for the same company?