Investing Your Cash
Cash is truly money in the bank. Cash needs to earn interest, but at the same time be safe and available to withdraw quickly. Banks and investment companies provide accounts to hold your cash and pay you interest. They loan your money out to borrowers and in turn pay interest back to you for letting them use your money. It's pleasing to see the balance increase with each statement — if even just a small amount. And it's comforting to know that the balance isn't at risk … that the statement will always show an increase no matter what and your money is available, in full, anytime you may want it.
Understanding the terminology is key to being an informed, alert investor. When you hear someone use the words “fixed-income security,” in most cases they're saying the same thing as if they're saying “bond.” The words “interest” and “yield” aren't technically the same, but they're often used interchangeably.
What's Guaranteed Safe and What Isn't
There are two ways to invest your cash: savings accounts and money market accounts. Savings accounts are available at your bank or credit union and are usually insured by the Federal Deposit Insurance Corporation, or FDIC. Your financial institution will advertise that your deposits up to $100,000 per depositor are FDIC insured. This means that your money is safe regardless of what happens to the bank itself. There's a cost for this insurance, of course, and it's passed down to you in the form of slightly lower interest rates on insured deposits compared to uninsured, but still very safe, money market accounts.
Money Market Accounts
Money market accounts are offered by investment companies and banks as a way to invest money at better interest rates than plain vanilla savings accounts, with very low — but not zero — risk and with high liquidity.
The rate of inflation varies from year to year, but in a healthy, growing economy it is always there. Nearly everything you need to buy will be pricier in the years ahead. Don't fall into the trap of assuming that the dollars that make a nice income today will suffice in twenty or thirty years!
Money market interest is higher than savings account interest because the money manager hasn't paid for FDIC insurance. Your deposits in a money market account are only as secure as the financial company itself, however. Technically, if the company runs into trouble, you could lose some or all of the principal you invested. In practice, though, large financial entities have staked their reputations on their money market accounts. When the economy gets difficult, companies have been known to reduce their fees or even deposit some of their own money into their money market accounts to help them maintain value.
The money market accounts of large financial institutions are a great way to invest cash at a decent interest rate while maintaining quick access to your money.
Liquidity refers to how easily an investment can be converted into cash. To say a bank account is liquid means that you can withdraw the balance quickly and without losing value. Real estate, however, is generally considered illiquid because it may take a long time to sell and could sell for less than its purchase price.
Trading Liquidity for Interest
Investors are sometimes willing to sacrifice liquidity for higher interest. Certificates of Deposit, or CDs, are a safe, higher-interest alternative to money markets for cash you don't think you'll need for a while. The longer the maturity, the higher the interest you should expect to collect. Typical CDs mature in three months, six months, twelve months, or even two years. Earning higher interest is only fair to you, for letting a financial institution use your money and for risking the likelihood that inflation would have eroded some of your cash's value in the meantime.
