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Cash is looking more attractive to many investors and savers, at least on a temporary basis.
Now, after two years of rising interest rates and what may be a coming breather in the stock market, cash is looking more attractive to many investors and savers, at least on a temporary basis.
A well-balanced portfolio will always include some cash investments, but in times of relatively healthy interest rates, a temporary shift toward cash could prove to be a wise move. In early 2004, before the Fed began its steady parade of rising interest rates, yields for many six-month certificates of deposit (CDs) were less than 1 percent; five-year CDs were bringing in less than 3 percent. As of October of this year, even three-month CDs were yielding more than 5 percent. When you combine that kind of improvement in interest rates with the safety of Federal Deposit Insurance Corporation (FDIC) insurance up to $100,000 per institution, it's no wonder that CDs are enjoying a jump in popularity.
However, there are two other types of cash investments (other than the underside of your mattress and those puny bank savings accounts) that deserve serious consideration for that portion of your portfolio dedicated to cash equivalent investments - money market accounts and money market mutual funds.
Here's how they work:
At the time of this writing, money market funds are returning an average of 4 percent to 6 percent a year, which rivals the current return of CDs. The funds calculate interest daily, but pay it out only at the end of the month. If you sell your fund, all accrued interest will be paid at the time of sale.
Unlike accounts offered by banks, money market mutual funds are offered only by mutual fund companies. Like all mutual funds, they incur management costs. They invest only in short-term (13 months or less) debt securities of government agencies, banks and corporations. In fact, the Securities and Exchange Commission (SEC) requires the average maturity of investments in a money fund to be less than 90 days. This requirement serves to limit the risk of investing in money funds.
The selling prices of most funds are fixed by the issuers at $1 per share. That way, no matter when you buy or sell your shares, you know that the price per share will always be $1. Only the interest rate fluctuates depending on current market conditions, not the price per share.
Like bank money market accounts, money market funds are liquid. They impose no penalty for withdrawing money, unlike CDs that impose significant fees for withdrawing your money before the maturity date. You can also write checks from your money market fund.
Although money market funds are not FDIC insured, they are still safe because they hold only secure investments like treasury bills and other government debt securities and because of the SEC requirement that average maturity be maintained at less than 90 days. In addition, most mutual fund companies carry some form of private insurance to cover your investment.
In my view, money market funds are the wisest choice for a place to hold your money when you are between other investments, saving for a specific purchase such as a house or a car, or simply looking for a safe place to park your cash where it will be available when you need it.