Cash Investments

Checking Accounts.  Generally, checking accounts bear very little interest, if any.  However, they are insured by the FDIC up to $250,000.

Savings Accounts.  Also, not much in the way of interest.  Also insured to the limit by the FDIC.

High-Yield Bank Accounts.  These generally offer better rates than typical checking or savings accounts.  Usually, online banks without large overhead offer better rates than their typical brick and mortar counterparts.  Be careful with limited duration teaser rates that expire right after enrolling.

Money Market Accounts.  Slightly lower rates than Certificate of Deposit rates in exchange for increased liquidity.  An account-owner may have to pay a penalty if he/she leaves too little cash within the account.  These are generally FDIC insured as they are offered through banks and thrifts.

Money Market Funds.  Not insured, as they are not offered through a bank or thrift.  Can be purchased through brokerages.

Certificates of Deposit (CD’s).  Very safe as they are FDIC insured.  They usually pay more than money market rates.  However, the cash is usually “bound up” until the maturity date.

Why Cash?

 

Cash as an asset class has many advantages.

• It is well known and understood by those who hold it.  There are very few investors who don’t understand cash.  It is an asset that is even understood by children who operate lemonade stands.  It is simple, can be held in many forms and is comfortable to the owner when compared against various more complex instruments.  CD returns are also easily calculated.
  
• It is often insured against loss.  Currently, the Federal Deposit Insurance Corporation, or FDIC, insures bank and thrift deposits up to $250,000.  While offering interest on these funds, very few investments have such strong guarantees against loss.
• Liquidity.  Liquidity is the ability for any asset to be converted to cash.  Therefore, cash, by definition, can often be 100% liquid.  Owners of Certificates of deposit may have to surrender interest earned if invaded prematurely, but the principle generally is returned intact.
• Preservation of capital.  Not only is cash often insured it generally doesn’t decrease in value beyond the normal devaluation of the dollar. 
• Cash may be a very important part of asset allocation.   In times of deflation, asset prices generally fall.  Stock market prices tumble, many bond prices fall, and commodity items usually fall as well.  These falling prices are generally a result of less dollars, or credit, in circulation.  Because asset prices fall, the cash to purchase these assets becomes more valuable.  This deflation therefore, typically favors cash and cash equivalents, such as CD’s, money market funds and currency.

Why Not Cash?

 

Cash as an asset class has many disadvantages.

• Historical low returns.  For all of the benefits of cash, low returns on cash investments is generally regarded as the greatest drawback of cash investing.  Historically, cash has returned around 4%.  This rate is not far from the historical average annual rate of inflation.  This essentially means that the growth on cash investments has been negated by the rate of inflation the cash actually purchases.
• In periods of inflation, cash becomes less valuable.  Inflation is the increasing of the money supply.  This phenomenon of an increased money supply devalue