Cash Investments
Financial advisors will tell you that there are three types of investments you can make - stocks, bonds and cash. Some people treat cash as something you only need to keep on hand for daily or unexpected expenses in an emergency fund. But as we will see, cash can and should play an important role in nearly everyone's mix of investments as part of their portfolio.
Cash Assets
There is no doubt that having ready cash on hand as spending money is certainly a necessity for many of us. We also use cash to pay monthly bills when sending a check. We also like the idea of having some extra money handy in case an unexpected emergency expenses as they arise. Those are two very pretty compelling reasons to have and hold cash which earns us some return on our investment.
Allocating Assets
But, there are a number of other reasons to hold onto cash - even beyond a “rainy day fund” or “emergency fund”. In fact, asset allocation theory tells us there are several reasons which drive our need to hold onto cash. For example:
- Years Until Retirement: Maybe it is better said as, years until the money is needed in retirement. The point is, the closer you are to needing money, the more liquid an investment should be for easier access and reduced risk.
- Risk Tolerance: If you are the type of person who panics when your investments are performing poorly, then you're a good candidate for investing in cash based investments.
- Knowledge or Comfort with Alternative Investments: Unfortunately for some people, they are limited to their investment choices due to a lack of knowledge. This usually happens as someone first starts out and begins building their investment portfolio. It may also be that some people simply don't know how to invest their money so they hold onto cash, even in excess, which keeps them from build the wealth needed in retirement.
Advantages to Cash Investing
The primary advantage of cash is the preservation of capital, a fancy way of saying cash is a safe investment. If you place your money in a Money Market Account or Certificate of Deposit in a Credit Union or bank, usually they are insured against loss.
Another advantage of cash is that it prevents you from liquidating assets from other investments, such as mutual funds, stocks or bonds, when you have a large expense coming up. The last thing you want to do is have to sell a portion of your investment portfolio during a downturn in the market so you can pay for your daughter's wedding. Holding cash investments is simple a way to meet financial obligations.
Cash investments are also extremely liquid - that means they can be quickly exchanged for products or services we need. In fact, in most cases all we need to do is make a withdrawal from an account to have immediate access to our money.
Disadvantages of Cash Investing
On the other hand, the primary disadvantage of cash has to do with the overall return on a cash investment. Higher returns on investment go to those who are willing to take greater risks and that means relatively safe investments such as cash will provide relatively low returns on investment. Savings accounts at one point use to pay a higher rate of return than they do today. Today savings accounts actually lose money through inflation and taxation.
This is one of the reasons why many investors spend time trying to figure out how much cash they need on hand versus how much to invest for higher returns on their investments. Investing puts our money to work for us and if too much money is sitting around idle we are missing out on greater returns.
Where to Invest our Cash
If you're convinced that cash can, and should, play an important role in your investment portfolio then you've really got four options when it comes to cash investments:
+ Certificates of Deposit
+ Money Market Mutual Funds
+ Money Market Accounts – banks & Credit Unions
+ High Yield Checking/Savings Accounts
Certificates of Deposit
If you're an investor searching for a relative low risk investment, then certificates of deposits (CD) are a good choice. A CD is nothing more than a deposit account. A banks typically offer a higher rate of interest over a traditional savings account. CD’s typically carry federal deposit insurance coverage up to $100,000.
With CD’s you are investing a fixed amount of cash for a fixed period of time. Common terms you will find are three months, six months, one year, three or five years. There are a few CD’s with longer terms but they require much higher deposits. Interest is paid to a CD at predetermined intervals, usually monthly, but sometimes quarterly or yearly. CD's that are redeemed early are often subject to a penalty.
Before buying a CD make sure you understand all the terms and conditions associated with the deposit, including:
- Maturity Date: find out when the CD matures, most banks will provide this information in writing.
- Early Withdrawal Penalties: find out what early withdrawal penalties exist, such penalties are usually stated in the terms and you lose any earned interest payments.
- Callable CD's: a callable CD gives the bank the right to call in a CD after a set period of time. So if interest rates suddenly fall, the bank can call in a CD.
- Brokered CD's: if you're planning on investing a lot of money in CD's, then you need to understand if the CD deposit is being brokered. FDIC insurance is on a per institution basis with a limit of $100,000 so you'll want to make sure all of your CD's are not with the same financial institution.
Money Market Mutual Funds
Money Market Mutual Funds are offered through investment brokers or companies usually not banks which invest in short-term debt instruments. Money market mutual funds invest in certificates of deposits, government securities, commercial paper of companies, and other low-risk, highly-liquid securities. These are not insured by the FDIC.
Money Market Accounts
Unlike the mutual fund, these are insured under the FDIC up to one hundred thousand. You should check with your bank or Credit Union for terms and interest rates.
High Yield Checking / Savings Accounts
Although the exact rules vary slightly with respect to high yield checking accounts and money market accounts but for most of us these two investments are nearly identical. These types of accounts are typically offered through online, and a few local, banks.
In exchange for offering higher yields than typical savings accounts, high yield checking or savings accounts normally have a fairly high minimum balance requirements. There may also be restrictions with respect to the number of transactions allowed each month. You may be subject to penalties if you exceed these thresholds. Banks limit the number of transactions so they can invest the money in higher yield investments which makes the money less available for immediate withdraw.
The important point to remember with cash investments is this: before investing cash in any of the mentioned accounts make sure you understand all of the funds terms and conditions. Ultimately it's your money and you need to understand all the rules associated with gaining access to that money as well as returns on investment. Having cash on hand is an important investment strategy as long as it is not used exclusively excluding all other means of investment.
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