Cash is a critical part of an overall financial strategy. A risk with cash is that is can build up, providing unneeded easy access and a low-interest rate. To combat the risk, try to match cash to scheduled liabilities and maximize the return. Cash investment strategies can include money market accounts, ladders of certificates of deposit (CDs) or short/intermediate bond mutual funds.
We wrote about having an inventory of assets. Now, let's finish the accounting by looking at bills and expenses you have planned for, such as normal household expenses, future down payments for cars or a house, or imminent college bills. The cash accumulated to pay these expenses come due at different times.
Cataloging expenses make it easier to determine the appropriate options for investing available cash. In this way, cash does not have to be viewed as a single category and invested in one account. Better returns are available for matching the timing of expenses to the most suitable investment options. The table below attempts to match liabilities to some appropriate investments.
,Park Your Cash in the Right Place. A common and easily accessible investment for individuals is CDs. They offer safety of principal and can be found in maturities appropriate for matching short-term liabilities. The yield an investor can expect to receive is often comparable to similar-maturity U.S. Treasury notes. When used to match a future liability the return is attractive. But look closely at your use of long-term CDs because they probably aren’t keeping pace with inflation, which means you could end out losing purchasing power.
With CDs so popular and readily available let's take a look at some specific benefits and risks of implementing them in an asset portfolio.
Some of the Risks---
Liquidity is Limited
An early termination penalty may be charged in the form of sacrificed interest or even loss of principal. A CD ladder will increase flexibility but now you risk smaller orders and bigger markups.
Low Relative Value
Low-risk investments, such as CDs, generally offer lower returns than high-risk, high-return investments.
When interest rates are trending downward, income payments and maturing CDs will invest at lower yields. This is known as reinvestment risk. This risk can work in your favor when rate trend upward.
Some of the Benefits---
Bank CDs are insured by the Federal Deposit Insurance Corp. an independent government agency. Credit unions CDs are insured by the National Credit Union Association.
Fixed Predictable Returns
Unlike other types of deposit accounts, savers can count on CDs to deliver a specific yield at a specific time. Even if interest rates fall, your rate will remain constant for the term of the traditional CD.
CDs are available in an assortment of maturities and yields from thousands of different banks and credit unions. BankRate.com is a good source for researching prevailing rates.
Building an inventory of expenses and savings will help you allocation to appropriate cash investments. For individuals, CDs are an ideal investment tool for cash management offering safety of principal, competitive yield and easy implementation. We suggest you extend your financial inventory exercise to all of your assets and liabilities to help determine every asset’s role in your financial strategy. Markets and your objectives can change frequently so it is important to review your financial strategy at least annually. This is the type of direction that can be provided by Laurentide Advisory. We understand the wide array of opportunities available in the marketplace and can help match your individual needs to the most suitable options the market has to offer to help meet those needs.
John Kirby is a Principal and Co-Founder of Laurentide Advisory