Asset No. 3: Cash Investments

Cash investments include things like Treasury bills, savings accounts, money-market deposit accounts, money-market mutual funds and certificates of deposit, where there’s little chance you will lose money and which can typically be sold at short notice (though, in the case of CDs, there will usually be an early-withdrawal penalty).

Historically, cash investments like Treasury bills and money-market mutual funds have paid a yield that roughly approximates the inflation rate. That means they can help preserve the spending power of your money before taxes, but you’ll likely find you are losing money, once the taxman gets his share. In recent years, however, it’s been far worse, as the Federal Reserve has kept short-term interest rates close to zero in an effort to stimulate the U.S. economy.

In addition to the long-run threat from inflation and taxes, holders of cash investments have also suffered the occasional short-term scare. During the 2008–09 financial crisis, accountholders at failed banks had uneasy moments, even if they were eventually made whole, thanks to FDIC insurance. Over the past four decades, a few money-market mutual funds have “broken the buck,” with their share price falling below the standard $1 net asset value. Perhaps the most notable failure was the Reserve Primary Fund, which slipped to 97 cents in September 2008.

Still, cash investments are far safer than stocks or bonds. Got money you expect to spend within the next year or two? Cash investments are typically the only prudent choice, given the chance of short-term losses with anything riskier. To find higher-yielding CDs and savings accounts, head to Bankrate.com.

What if you plan to hold cash investments as part of your longer-term portfolio? If you have a 401(k) plan at work that includes a stable-value fund, you might keep your cash allocation in the fund, which may offer a somewhat higher yield than, say, a money-market mutual fund. You could also keep longer-term cash holdings in short-term bonds, which will give you a higher yield, though there is a risk you’ll have a year with modest losses. Alternatively, you might purchase longer-term CDs to get a higher yield, figuring that higher yield will compensate for any early-withdrawal penalty, should you need to cash out before maturity.

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