Cash Equivalents
By: Source: AARP.org Date Posted: 2006-04-17 12:43:48.744570-04:00
Cash by any Other Name
Cash equivalents refer to accounts that are as safe as cash, may earn a small amount of interest and can be converted into cash relatively quickly. The most common examples of cash equivalents are:
- Savings deposits
- Certificates of Deposit (CDs)
- Money market accounts
- Money market mutual funds
Read Where to Save for more information on these cash equivalents.
When you deposit your money, you're actually lending it to a financial institution. They, in turn, lend your money to businesses and government agencies that want to borrow it. The financial institution earns interest on the loans and then pays some or all of that interest to you. Generally, savings vehicles are very safe. With the exception of CDs, when you want your money back, you can withdraw it quickly without penalty.
Why cash?
Savers buy them so they can put their money in a safe place where they can quickly access it. Investors buy cash equivalents for a temporary "parking place" for their money while they're deciding what new investments to make.
Savings deposits, CDs and money market accounts are insured by FDIC, a federal government agency, for up to $100,000 per investor. Money market mutual funds are not FDIC insured, but most have SPIC coverage, a private insurance program for mutual fund companies and brokerage firms. For these reasons, cash equivalents tend to have considerably less investment risk than stocks or bonds.
The biggest risk to cash equivalents is simply inflation. If inflation occurs at a higher rate than what you are earning from your cash equivalents, your money loses its purchasing power. For example, if you earn 1% from a savings account and inflation is running at 2%, your money isn't keep up with the rising cost of goods and services. A $100 in your savings account will grow to $101 by the end of the year, but a coat that costs $100 today will increase in price to $102 over the same time period.
Additional Resources
Read the Security and Exchange Commission's fact sheet called "Certificates of Deposit: Tips for Investors." It also includes a list of banking regulators that you can call if you have a complaint.
Additional Related Links
Allocating Your Money to Meet Your Goals
Cash Equivalents
preview