The True Cost Of Cashing In Your Investments

Cash investments are a short-term, low-risk way to grow your money. They are highly liquid, meaning you can convert them to cash quickly and easily without losing value. Cash investments include money market accounts, money market funds, and certificates of deposit (CDs). They are a good option for those who need a temporary place to store their money while they research other investment opportunities, or for those who want to preserve their capital. However, the trade-off for the low risk and high liquidity of cash investments is that they tend to generate more modest returns than stocks or bonds.

Cash investments vs other investments

Cash investments are short-term obligations, usually fewer than 90 days, that provide a return in the form of interest payments. They are highly liquid, low-risk investments with a short maturity period, usually less than three months. Cash investments include money market accounts (MMAs) and certificates of deposit (CDs).

Cash investments are a good option for those looking for a safe investment and wanting to preserve their capital. They are also a good option for those who need a temporary place to keep their cash while researching other investment products.

However, cash investments generally offer a low return compared to other investments, such as stocks. While cash investments can provide a buffer against fluctuations in the value of more volatile assets, they typically don't provide enough growth to outpace taxes and inflation over the long run.

For example, if you put $10,000 in a money market account earning 4% interest, you'd accumulate $20,300 after 18 years. If inflation averaged 4% per year, your account would actually be worth $10,150. After taxes, you'd have less buying power than when you started.

On the other hand, if you invested the same amount in a portfolio of stocks earning an average of 8% for 18 years, you'd have $40,000. After accounting for inflation, you'd still have $20,000, or twice what you started with.

Therefore, while cash investments can be a good option for short-term goals and emergency funds, they may not be the best choice for long-term investment goals. It's important to consider your risk tolerance, time horizon, and financial goals when deciding between cash investments and other investments.

The benefits and risks of cash

When considering cashing in investments, it is important to understand the benefits and risks associated with cash.

Benefits of Cash:

• Freedom and Autonomy: Cash is the only form of money that does not require a third party or any specialised equipment to transact with. It can be used anywhere, regardless of access to electricity or technology, and is universally accepted.
• Privacy: Cash transactions protect your personal and financial data, reducing the risk of intrusive tracking and advertising practices.
• Immediate Settlement: Cash transactions are immediate and do not require additional processing time, unlike electronic payments.
• No Transaction Fees: Cash transactions are free, unlike debit and credit card payments, which usually incur fees.
• No Dependency on Technology: Cash does not rely on technology such as card machines or internet connections, making it useful in situations where such infrastructure is unavailable or impractical.
• Budgeting Control: Using cash can help individuals manage their budgets more effectively as they can only spend the physical cash they have on hand, reducing the risk of overspending.
• Security: Cash carries a lower risk of fraud and identity theft compared to electronic payments.
• Inclusion: Cash is crucial for financial inclusion, especially for those without access to banking services or digital payment methods.
• Emergency Usefulness: In emergency situations, cash can be essential when electronic systems may be disrupted.

Risks of Cash:

• Security Risks: Carrying large amounts of cash can attract thieves and increase the chance of loss.
• Lack of Traceability: Cash transactions do not provide an electronic trail, making it difficult to track spending patterns over time. This can be inconvenient for budgeting, tax, and expense-tracking purposes.
• Inconvenience for Large Transactions: Handling large amounts of cash is impractical and cumbersome, especially for significant purchases or payments.
• Counterfeiting: Counterfeit cash is a persistent issue, and individuals and businesses must take steps to detect and mitigate this risk.
• Limited Acceptance: In some areas, particularly urban or technologically advanced cities, vendors may prefer or exclusively accept electronic payments.
• Inconvenience for Remote Transactions: Cash is not suitable for remote or long-distance transactions, such as online shopping or bill payments.
• Inefficiency for International Transactions: Cash is bulky and inconvenient for international travel and transactions, especially with varying currencies and exchange rates.
• No Rewards or Benefits: Cash does not offer secondary benefits like cashback or reward points, unlike some electronic payment methods.
• Reinvestment Risk: Cash yields may not keep up with inflation, and short-term interest rates can change quickly, impacting future investments.

While cash offers benefits such as freedom, privacy, and budgeting control, it is important to be aware of the risks, including security concerns, lack of traceability, and limited acceptance in certain situations.

Cash investments and savings products

Some examples of cash investments include cash management accounts, money market funds, and certificates of deposit (CDs).

Cash Management Accounts

These are typically offered by non-bank financial institutions, such as brokerage firms. They function as an alternative to a traditional bank savings account and often provide features like Federal Deposit Insurance Corporation (FDIC) insurance and an annual percentage yield (APY). The Vanguard Cash Plus Account is one example of a cash management account.

Money Market Funds

Money market funds are a type of mutual fund with ultra-short-term maturities, typically from a few days to one year. They are considered lower-risk investments with stable share prices and high liquidity. Money market funds invest in low-risk assets, such as U.S. Treasury bills and CDs, making them one of the safest investment options. They may also offer higher returns than traditional savings accounts.

Certificates of Deposit (CDs)

CDs are promissory notes issued by banks, similar to bonds. They have a specified interest rate and maturity date, usually five years or less. CDs offer stable principal amounts and generally higher yields than some other investment options. They are insured by the FDIC and considered safe if held until maturity.

While cash investments provide a safe and flexible option, it's important to balance them with other investments. Holding too much cash can make it challenging to meet long-term financial goals.

Cash allocation in a portfolio

Cash investments are typically short-term obligations, usually fewer than 90 days, that provide a return in the form of interest payments. They are highly liquid, have minimal market risk, and a short maturity period. Cash investments include money market accounts and certificates of deposit (CDs).

While cash investments are generally considered safe, they offer low returns compared to other investments. They are often used as a temporary place to keep cash while researching other investment products or to preserve capital.

When determining how much cash to allocate in a portfolio, it is essential to consider your investment goals, risk tolerance, and time horizon. Here are some factors to consider when allocating cash in a portfolio:

• Emergency fund: It is generally recommended to keep at least three to six months' worth of living expenses in a highly liquid form, such as a bank savings or checking account. This emergency fund ensures that you have access to cash during unexpected situations without having to sell other assets.
• Investment opportunities: Keeping some cash on hand allows you to take advantage of investment opportunities that may arise. This strategy provides the flexibility to invest when asset prices fall.
• Diversification: Diversifying your portfolio across different asset classes, including cash, stocks, and bonds, can help minimize risk. While stocks and bonds offer higher returns, they come with higher volatility. Cash investments provide stability and liquidity to your portfolio.
• Risk tolerance: If you have a low-risk tolerance, you may want to allocate a larger portion of your portfolio to cash. Cash investments are FDIC-insured and offer principal protection.
• Investment horizon: If you are investing for the long term, such as for retirement, you may want to allocate a smaller portion of your portfolio to cash. Long-term investment horizons allow you to take advantage of the higher returns offered by stocks and bonds.

It is important to note that there is no one-size-fits-all approach to cash allocation in a portfolio. The optimal cash allocation will depend on your personal financial situation, goals, and risk tolerance.

Additionally, it is worth mentioning that while cash investments provide stability and liquidity, they may not keep up with inflation over the long term. Therefore, it is crucial to balance your cash allocation with other investments to ensure your portfolio grows at a rate that meets your financial goals.

Cash investments for short-term goals

Cash investments are a great way to save for short-term goals. They are readily available, short-term financial instruments with high liquidity, minimal market risk, and a short maturity period—usually less than three months.

When saving for short-term goals, it is important to put money into less risky investments that will earn returns while also preserving the principal amount. Since you are saving for a goal that you need to meet relatively quickly, you cannot afford to lock your money into investments with long-term maturities, nor can you invest in the stock market, which can be volatile.

• Cash management accounts: These accounts combine the features of checking and savings accounts, offering benefits such as competitive interest rates and minimal fees. They are usually offered by non-bank financial institutions like brokerage firms or robo-advisors.
• Money market mutual funds: These funds invest in low-risk, short-term debt instruments, cash, and cash equivalents. They are considered lower-risk investments with stable share prices and high liquidity. Money market funds can be purchased through mutual fund brokerage firms.
• Certificates of Deposit (CDs): CDs are short-term investments, usually ranging from a few months to several years. They offer higher yields than most savings accounts but are less liquid due to early withdrawal penalties. CDs can be purchased through banks or credit unions, or as brokered CDs through brokerage firms.
• High-yield savings accounts: These accounts offer higher interest rates compared to traditional savings accounts and are a good option for those seeking low-risk investments. They are available at banks, credit unions, and online banks, offering easy access to funds.
• Short-term corporate bond funds: These funds are a diversified portfolio of bonds from various companies and industries, offering higher returns than savings accounts. They can be purchased through online brokers offering ETF and mutual funds.
• Short-term US government bond funds: These funds are considered very safe as they are backed by the full faith and credit of the US government. They offer a reliable interest rate and can be purchased through online brokers offering ETF and mutual funds.

Frequently asked questions