Do you have bundles of cash just sitting around?
If you do, congratulations – you have a world of opportunities available to you and can seriously grow your net wealth. Cash, far more than credit, is the must-have asset in today’s economy. It is always in demand – but unless you actually do something with it, cash doesn’t accumulate on its own.
In fact, it decreases – something we’ll talk about later.
For now, we’ll discuss the ins and outs of putting your idle cash to work, including what you need to understand and look for and what options are available to you.
Cash is a great asset – but it is a vulnerable asset. Think of investing it as protecting it; even if you don’t get a fantastic return, you are still better off than if you just leave it lying around.
Why is that? One word: Inflation.
Let’s say you have $100 in cold, hard cash. You decide you want to save it, so you place it under your mattress (or in a savings account; the rate of return is almost the same).
What happens to that $100? Well, five years from now, that $100 will shrink. Not physically, but it’ll shrink nonetheless because inflation eats into the buying power of every dollar in cash that you own. $100 today doesn’t have the same buying power as $100 10 years did; back in 2002, your relative purchasing power was $125.
In essence, your dollar had 25% more bang for its buck 10 years ago. Go back further to 1992 and the number climbs to $160. Want to know what it was 30 years ago? Try $233.
The point of all this is to show you that unless you put your money to work, it will, if left alone, gradually lose buying power. The only way to actually protect it is to place it somewhere where the power of compound interest works against inflation and for your money.
Options for Investment
So, if you want to put it somewhere, where can you go? Before we cover those options, let’s look at a few concepts we want to cover first.
When you determine which avenue for investment you want, the major concept you are looking for is the rate of return. All things considered equal, you want the highest rate of return possible. Different investment vehicles have different rates.
A concept that goes hand-in-hand with rate of return is risk. Generally, risk and rate of return are inversely proportionate. When one goes up, the other goes down. High-risk assets are high-reward assets, and low-risk assets are low-reward assets. That’s why your savings account probably has a paltry rate of return; it’s a safe investment that demands a lower interest rate.
Finally, you have to take into account the duration or investment timeline of your asset. Some assets, like certificates of deposit, are time-restricted in that you place your money into an account and cannot withdraw it until it reaches maturity (at least, not without paying a penalty). A one-year CD, for example, effectively locks up your money for a year. A Treasury bond – the asset offered by the U.S. Government with the longest maturity – doesn’t mature for 20-30 years. The longer the maturity, the higher the return – and the more risk you’ll take on.
Another way to look at this is to look at the liquidity of your asset. This is how easy the asset is to convert into cash. A stock is highly liquid; at any time, you can sell a stock for cash (as long as there are buyers for it). Any asset with a timeline is not as liquid, and some, like CDs, are highly illiquid. Real estate and any other real, tangible properties are included in the list of the most illiquid assets.
Here are the general investment options you have when it comes to putting your idle cash to work:
Very; Can sell at any time
Very; Can sell at any time
Limited; Can’t “cash out” until maturity
Usually six months to 30 years
Very limited; Can’t “cash out” until maturity
One month to 15 years
|Money Market Accounts|
Very; Almost like cash
Depends on the specific asset purchased
|Real Estate Investment Trusts|
More liquid than real estate, not as liquid as MMAs
Depends on whether it is public or private
Mutual funds are collections of stocks (or other assets) that diversify your portfolio; as a result, they are less risky than stocks on average. A mutual fund can be costly, but if you want a diversified approach to playing in stocks, mutual funds are the solution.Stocks are highly liquid investments that form the bulk of most investment portfolios out there.
They do carry the most risk (unless you talk about exotic instruments like junk bonds or credit default swaps), but they also offer substantial return and give you a lot of flexibility when it comes to investing in them. (I won’t get into stock options here, but they do offer an opportunity to gain exposure to stocks without paying quite as much.)
Bonds come in many different types, but generally fall into three categories: government bonds (primarily U.S. Treasury securities); municipal bonds (city and local governments); and corporate bonds. The safest are U.S. Treasurys, followed by municipal bonds then corporate bonds. Corporate bonds generate the highest reward, but municipal bonds typically have tax advantages that can give you a better overall benefit.
CDs, as mentioned, provide you with a return based on the interest rate after a certain period of time. You can withdraw your money before maturity, but you’ll have to pay a penalty. Returns are very low, but are usually higher than those offered by savings accounts.
Money market accounts deal in cash and cash-like assets, which can range from short-term government bills to corporate assets (called paper). MMAs do not offer incredible returns, but they are liquid and safer than many other investments.
Finally, REITs offer you the chance to invest in real estate – particularly commercial real estate – without actually buying property. They can be publicly traded on exchanges or held privately (private REITs have investment timelines that reduces their liquidity). Their value is based off rent and other proceeds from commercial properties. REITs suffered after the real estate market crash of 2007, but are regaining in value.
No matter what asset you choose, ultimately the best decision is to put your cash to work. You want to generate a high enough return to outpace inflation, which means most savings accounts simply won’t do. (Many CDs won’t, either). Keep in mind your desired rate of return, your risk profile, and how accessible you want your cash to be.