Questions You Were Afraid to Ask #11
The only bad question is the one left unasked. That’s the premise behind many of our recent letters. Each covers a different investment-related question that many people have but are afraid to ask. In the next few messages of the series, we want to address some questions we’ve been hearing lately about recent investing trends. We’ll start with…
Questions You Were Afraid to Ask #11:
What does it mean to invest in cash?
Sometimes, an investor will see a headline that mentions the word “cash.” Here are some examples just from the last year or so:
“Cash is king again.”
“Warren Buffett sits tight on cash.”
“No more ‘cash is trash’ billionaire hedge fund manager says.”
“How much of an investment portfolio should be in cash?”
Headlines like these often bewilder new investors. But even experienced investors sometimes wonder: “What does it mean to invest in cash?” After all, we don’t usually think of the word “cash” in relation to investing. For most people, cash is the stuff you keep in your wallet. So, what gives?
This is a textbook example of an intelligent question people are often afraid to ask.
Fortunately, “investing in cash” is a fairly simple concept. It means to invest in a type of short-term security for a set period of time in exchange for one or more interest-rate payments.
Certificates of deposit (CDs), money market accounts, and treasury bills are three examples. These securities are known as “cash equivalent” investments, but the word “cash” alone is often used as an umbrella term to cover all the various types. That’s because these types of investments are very liquid. That means the funds inside them can be converted to actual cash – money you can spend at a moment’s notice – quickly and easily compared to stocks, bonds, or investment accounts like a 401(k) or IRA. (Stocks and bonds aren’t always easy to sell, and depending on the timing, you may sell for a lower amount than what you paid for. Meanwhile, withdrawing the money from an IRA or 401(k) before you retire can trigger financial penalties from the government.)
That’s why these types of securities are referred to as “investing in cash.” They still provide a return – hence the investing part – but also a level of liquidity close to actual, physical currency.
Cash investments are handy if you have money that you:
- Want to keep safe. Money markets and certificates of deposit are historically stable investments and are often insured up to a certain point by the federal government.
- Want to earn a return on. In the form of interest rate payments, which are generally higher than with a basic savings account.
- Want easy access to within a relatively short period of time. Most money markets have a maturity of six months or less. Treasury bills mature within one year or less. CDs, meanwhile, usually have a maturity of 6 months to a few years.
That said, there are some downsides to investing in cash. For one thing, if your focus is on growing your money, there are usually much better options. That’s why many investors often shun putting too much money into cash. They feel there are more productive ways to invest. And while they are very liquid compared to other securities, there are still penalties if you withdraw the money from a CD before maturity. (Money markets don’t have an early withdrawal penalty, but many banks and credit unions will charge monthly fees if the balance falls below a certain minimum.)
With all this in mind, why have we seen so many headlines about “cash” in recent years? It all has to do with interest rates. As you probably know, the Federal Reserve has been gradually hiking rates for much of the past two years to bring down inflation. When the Fed raises rates, banks and credit unions usually follow suit. As a result, some cash investments have been paying higher interest rates than normal. This, coupled with a volatile stock market, has caused cash to gain in popularity with some investors.
How long this trend continues is impossible to know. And it’s worth emphasizing that cash, like all securities, is an investment that is sometimes right for some people in some situations…not always right for all people all the time. So, if you’re interested in cash investments, be sure to talk about it with a qualified financial professional first to make sure it’s right for you.
In the meantime, now you know what it means to “invest in cash.” In our next post, we’ll discuss another recent investing trend. Have a great month!
