Cash Or Invest: Where Should Your Money Go?

Cash investments are a great way to balance your portfolio and protect your capital. They are short-term, highly liquid, and low-risk obligations that generally mature in less than 90 days. These investments are ideal for those seeking capital preservation and low risk. While cash investments yield lower returns compared to stocks or bonds, they are a safer option during market downturns. Money market accounts and certificates of deposit are popular choices for cash investments.

Money market accounts (MMAs) and certificates of deposit (CDs)

Money Market Accounts (MMAs)

MMAs are a type of mutual fund that invests in short-term, interest-bearing instruments, offering a variable yield while preserving the principal amount. They are highly liquid, allowing account holders to access their funds with few restrictions. During the COVID-19 pandemic, the limit of six convenient withdrawals per month was suspended, and currently, there are no restrictions on the number of withdrawals. However, financial institutions may impose their own limits. MMAs usually come with a debit card and/or checkbook, making it easier to access funds. They are suitable for those who need easy access to their money and are ideal for short-term savings goals.

Certificates of Deposit (CDs)

CDs, on the other hand, are timed deposits that provide a fixed interest rate tied to a maturity date. They are less liquid than MMAs, as withdrawing money prior to the maturity date typically incurs a penalty. Longer-term CDs tend to offer higher interest rates, and the best CD rates can rival or beat other deposit accounts. CDs are ideal for those with a long-term savings plan and those who want to lock in a high annual percentage yield (APY).

Choosing Between MMAs and CDs

The choice between an MMA and a CD depends on individual objectives and liquidity needs. If you may need immediate access to your cash, an MMA is a better option. However, if you are certain you won't need the money in the short term and want to lock in a higher yield, a CD is the way to go. CDs are also a good choice for funding goals within a 10-year time frame, as you won't want to risk the price fluctuations of market-based options.

Mutual funds

All mutual funds have fees, which can be charged at specific times or on an ongoing basis. These fees and expenses can vary widely from fund to fund or fund class to fund class. Even small differences in expenses might significantly impact your return over time.

There are several types of mutual funds, including:

• Stock funds, which invest in stocks
• Bond funds, which invest in bonds
• Balanced funds, which invest in a combination of stocks and bonds
• Money market funds, which invest in very short-term investments and are sometimes described as cash equivalents

Money market funds are a type of mutual fund that invests in low-risk, short-term debt securities, such as Treasury bills, municipal debt, or corporate bonds. They are designed to offer a safe, stable investment option for money that may be needed in the short term, such as an emergency fund or a short-term goal. Money market funds are considered extremely low-risk and are intended to maintain a net asset value (NAV) of $1 per share.

Stocks

While stocks can be a valuable long-term investment, they are also susceptible to market volatility and downturns. In such situations, investors may be tempted to sell their stocks and move their money into cash to avoid further losses. However, this strategy may not always be wise in the long term, as it involves selling stocks at a low price and missing out on potential gains when the market rebounds.

A recommended approach is to maintain a balanced portfolio that includes both stocks and cash. The amount allocated to each will depend on various factors, such as an individual's financial goals, risk tolerance, and life stage. For example, retirees may want to hold a larger proportion of their portfolio in cash to provide peace of mind and meet income needs during retirement. In contrast, individuals with a higher risk tolerance and a longer time horizon may opt for a smaller cash position, investing more heavily in stocks to take advantage of potential higher returns.

Overall, stocks can be a valuable component of an investment portfolio, but it is important to consider the potential risks and volatility associated with them and maintain an appropriate balance with other types of investments, such as cash.

Bonds

However, it is important to consider the risks associated with bond investments. Bonds carry the risk of losing value if the underlying issuer defaults or goes bankrupt. Additionally, rising interest rates can lead to a decrease in the market value of bonds, making them less attractive to buyers. The longer the maturity of a bond, the higher the interest rate risk it carries.

When investing in bonds, it is crucial to assess the credit rating of the issuer. Independent bond rating agencies, such as Standard & Poor's (S&P) and Moody's Investors Service, evaluate the financial health and creditworthiness of bond issuers. Bonds with higher credit ratings are generally considered safer investments but offer lower interest rates. On the other hand, high-yield bonds, often referred to as "junk bonds," carry higher credit risk and are more susceptible to market fluctuations.

Corporate bonds, on the other hand, are issued by companies to fund their investments. These bonds carry a higher degree of credit risk, depending on the financial health and stability of the issuing company. The interest rates on corporate bonds vary based on the company's credit rating, with higher-quality bonds offering lower interest rates.

Overall, bonds play a crucial role in diversifying investment portfolios and providing a stable source of income for investors, especially during uncertain economic times. However, it is important to carefully assess the risks and potential returns associated with different types of bonds before making any investment decisions.

Cash flow from investing activities

CFI accounts for purchases of long-term assets, namely capital expenditures (CapEx) and business acquisitions or divestitures. Investing activities include the purchase of physical assets, investments in securities, or the sale of securities or assets.

• Purchase of property, plant, and equipment (PP&E)
• Proceeds from the sale of PP&E
• Acquisitions of other businesses or companies
• Proceeds from the sale of other businesses
• Purchases of marketable securities (stocks, bonds, etc.)
• Proceeds from the sale of marketable securities
• Making and collecting loans (except for program loans)
• Acquisition and disposition of debt or equity instruments

The formula for calculating the cash flow from investing activities is:

Note: divestitures refer to the sale of investments.

A negative CFI does not always indicate poor financial health. It often means that the company is investing in assets, research, or other long-term development activities that are important for the health and continued operations of the company.

Frequently asked questions