In any investment, cash is the most important part of a financial portfolio, be it for personal or business use. Cash helps preserve your capital assets, keeping the flow of your money for spending and other ways where you can invest it. By the word itself, cash equivalents refer to those assets that you have which can convert easily into cash, whenever the time of need comes. This can be in the form of market holdings, government treasury bills, commercial papers, or securities. Cash equivalents can also be used as a collateral for your loans.
Cash equivalents give you higher returns than the usual savings account you have with your bank. For example, if you plan a long-term investment in federal bonds, you will receive yields at the maturity value of your bond. You may earn more than the interest rate that your savings normally have, where you have low risks compared to stock investments.Is it Smart to Invest in Cash Equivalents?
One great advantage of having cash equivalents is its liquidity, where you can easily convert your assets back to cash with very little loss. You can withdraw your investment anytime you wish. Cash equivalents also protect you from the high risks of stock investments, where prices of your shares vary on the current market, making you sell at high or low prices. Although the interest rates you will earn on cash equivalents are lower to other types of investments, where long term investment comes the risk of inflation, cash equivalents just give you an added safety net for uncertain times in the future.
What are the Types of Cash Equivalents?
Certificates of Deposits or CDs
These are bank products that are federally-insured, which run on typical terms of 14 days to 6 months. These come in $1M denominations, which may run on short terms and are often negotiable. Because of its large size and yield, many investors put their money on this type of cash equivalent.
US Treasury Bills or T-Bills
These are cash equivalents totally supported by the US federal government, and issued by them. It has a short term of one year, or even less, and offers risk-free returns. This type of investment is more affordable to the working individual who wants to invest $10,000 – which is the minimum for this type of cash equivalent. You earn when your T-Bill faces maturity.
Money Market Funds
These are cash equivalents that are not insured federally, which uses your cash in low-risk investments like government securities. By seeking to secure a value of a dollar per share, money market funds are available in large denominations. Investments are run in short term, which come at low risks as well. The convenience of this cash equivalent makes it a nice choice where you can write a check when you need money.
Commercial Paper
This type of cash equivalent matures in a year or less, which are often found in money market funds. Maximum maturity can last up to 270 days. These are used by corporations when they need finances on accounts receivables and other inventories. The risks are higher than that of CDs and securities.
A trick of the trade is to set a portion of your assets to cash equivalents which you might need anytime, and another in long-term investments with higher returns. Cash equivalents are easily negotiable in times of needs, without the unnecessary risk of carrying your cash and credit cards around. Besides, it can give you that financial satisfaction for a short time period. Invest Wisely!
RESOURCES:
HSBC. “ Cash Equivalents. “ 2009.
http://www.yourmoneycounts.com/ymc/goals/investing/cash_equivalents.html
Investopedia ULC. “ Series 65: Cash Equivalents and Fixed Income Securities. “ 2009.
http://www.investopedia.com/exam-guide/series-65/cash-equivalents-fixed/default.asp
Tatum, Malcolm. “ What are Cash Equivalents? “ 2003-2009. WiseGeek.com.
http://www.wisegeek.com/what-are-cash-equivalents.htm
Wikipedia. “ Cash and Cash Equivalents. “ September 2009.
http://en.wikipedia.org/wiki/Cash_and_cash_equivalents