Alpha Teach Yourself Investing in 24 Hours: An Analysis (part 12)

Cash Equivalents

by

Charles Lamson

Cash equivalents are those instruments that serve as short-term parking places for cash. They are discussed in the following sections of this post.

Money Market Accounts

I have included money market accounts here, even though they are also mutual funds because they are designed as short-term holding strategies for excess cash. They differ from regular mutual funds in that they only invest in other cash instruments.

Money market accounts typically pay more interest than regular savings accounts, although not enough to warrant leaving large sums of money in them for extended periods. If you keep an emergency cash reserve, a money market account would be a good choice.

They offer check-writing privileges, although most have some restrictions. One way people use them is to keep only enough in their regular checking account to cover their monthly expenses. They will often deposit all of their income into the money market account and then write themselves one check to cover all the bills.

JUST A MINUTE Money market funds usually offer a better rate of return  than savings and have check-writing privelages.

Many stock brokerages will offer access to a money market account as a place to park uninvested cash temporarily. For example, if you sell a stock and intend to invest the money in another stock, but are waiting for your price, you might park your cash in a money market account.

Cash Management Accounts

Cash management accounts are similar in function to money market accounts, but they are not mutual funds. Brokers typically offer them as a service to high-end investors.

The accounts have check-writing privileges and a debit card to access ATM networks for cash. They sometimes utilize a "sweep" feature that will automatically move uninvested cash into an interest-bearing account and back into the checking account when needed.

Bank Certificates of Deposit (CDs)

Certificates of deposit are accounts offered by banks that pay a higher interest rate than regular savings accounts in exchange for the depositor locking up his or her money for a period of time.

They are insured (up to $100,000) by the Federal Deposit Insurance Company (FDIC), which is part of the federal government. You have probably seen the "Insured by FDIC" signs in your local bank. About the only reason to use CDs is if this insurance is important to you. They also might be of limited value if you knew you needed a certain sum of money on a certain date in the future.

If your child needs a college tuition payment in September, it might make sense to park that money short-term (one year or less) in a CD that would mature on or before the date tuition is due.

As a long-term (one year or more) strategy, they do not make much sense except in very rare cases. For instance, back in the 70s when inflation was high and the interest rates on CDs in the double digits, keeping your money in a CD was common.

Regular Savings Accounts

I have not even mentioned regular savings accounts. There are too many other places to put your money that would be more profitable. However, I would urge parents to consider opening a savings account for each of your young children as a learning tool.

JUST A MINUTE Open a savings account for your children and let them deposit a portion of their allowance, chore money, gifts, and so on in the account every month. This will get them in the habit of saving money and even help with planning for purchases. It is amazing to see the wheels of decision grinding in your children's heads when they realize that to buy a CD player, for example, they have to take money out of their own account---not Mom and Dad's.

Make a point of taking them to the bank on a regular basis and depositing some of their allowance, chore money, or gifts. you can't start too early getting them in the savings habit.

*SOURCE: ALPHA TEACH YOURSELF INVESTING IN 24 HOURS, 2000, KEN LITTLE, PGS. 60-62*

END

JUST A MINUTE

Money market funds usually offer a better rate of return  than savings and have

check-writing privelages.

JUST A MINUTE

Open a savings account for your children and let them deposit a portion of their allowance, chore money, gifts, and so on in the account every month. This will get them in the habit of saving money and even help with planning for purchases. It is amazing to see the wheels of decision grinding in your children's heads when they realize that to buy a CD player, for example, they have to take money out of their own account---not Mom and Dad's.