Jose Luis Pelaez Inc / Getty Images An investor could put cash into CDs, which can earn even more interest than typical bank accounts but lack the same liquidity. For example, a person might put some extra cash they don’t plan on needing right away into a five-year CD (CD terms vary from a few months to several years). If the CD holder can wait the full five years, then they will earn more interest than they would in a traditional bank account, without facing the volatility that other investments such as stocks could have. If the individual needs the money early, however, before the CD term ends, they can take the cash out but may have to pay a penalty. Investors typically aren’t taking on too much risk in these scenarios, especially if they park their cash in a bank account backed by the Federal Deposit Insurance Corp. (FDIC). In that case, even if the bank fails, individuals usually are insured for up to $250,000. Investors also might decide to put their cash into fixed-income investments with shorter terms. This type of cash investment is often made in short-term U.S. Treasury securities called T-bills or notes. That can help investors hold onto them until maturity to receive the full interest plus their principal back, because there’s not very long to wait.
How Do Cash Investments Work?
On its own, cash tends to decrease in value over time due to inflation. If you keep cash lying around in your wallet, home, or anywhere that does not earn interest, eventually that money is likely not to go as far as it once did. So, a cash investment can be used to help you keep up with inflation. Depending on the specific cash investment and current inflation rates, you might be slightly behind inflation, right in line with inflation, or slightly ahead. Making a cash investment could be something an individual chooses and sets up on their own, such as comparing CD rates at different banks to find the best option for their circumstances. Or an investor might find that a cash investment is made on their behalf, such as through their brokerage firm. If you have some cash in a brokerage account, then that brokerage might automatically put your cash into a sweep account, which makes relatively low-risk investments on your behalf to earn a modest return on your cash.
What Do Cash Investments Mean for Individual Investors?
While some individuals prefer to keep cash entirely as physical bills, making cash investments often can be another safe way to store your cash while earning a slight return. And because cash itself can erode in value over time due to inflation, one could argue that cash investments are safer than holding cash itself. When deciding what to do with your cash, consider the returns you could potentially earn, weighed against the risks. In addition to accounting for the risk of losing their cash in a bad investment, people also need to think about liquidity risk. If you put your cash into real estate, for example, it could take years to get your cash back, as opposed to withdrawing it from a bank at a moment’s notice. In contrast, cash investments often give you fast access to your funds while helping you earn a bit more from that money.
