Even though it seems to defy conventional wisdom, cash or cash equivalents can be an excellent investment. There are even some cases where cash is the best investment that a person can make.
The reason why cash is often an excellent investment is that it is liquid. That means you spend it immediately or right away. You will not have to pay a fee or take any special action to use cash. Therefore you can use it to cover expenses right away or take advantage of an opportunity.
Many investment experts recommend that families and individuals keep a cash reserve. Such a reserve should consist of several thousand dollars that you can access quickly. This cash can help you avoid debt and provide financial security. The creation of a reserve is one the best and most basic investment moves that you should take.
Advantages to Cash
The reason you need a reserve is all the advantages that cash has. The first and most obvious is that spending cash will not cost you anything. You will not have to pay interest on it and you will not accumulate further debt by using it. Spending cash will not diminish future earnings because you will not need to pay it back.
Having it available can help you avoid falling into the trap using debt instruments such as credit cards to cover day to day expenses. It can protect your credit rating and your ability to borrow. Even if you borrow, having a large amount of funds available can increase your ability to borrow and your credit rating
Disadvantages to Cash
There are some serious drawbacks to cash that you should be aware of. The first is inflation, money loses value, the usual inflation rate is 4% but inflation has risen as high as 19% at some points in American history. That means any funds kept as cash will lose value.
Another disadvantage is that cash will not earn any extra income on its own. Equities and securities will earn interest which can make up for inflation and increase in value. Most cash investments will only earn a low interest rate that is sometimes less than the rate of inflation.
Finally liquid funds will increase your income tax liability. You will have to report those funds on your tax return. That will probably increase your tax bill and could decrease your income.
How to Invest in Cash
The key to using cash as an investment is to find vehicles that function like cash but lack some of its drawbacks. You should always keep cash funds in insured bank accounts or investments such as CDs or money markets. These instruments are insured by the FDIC so there is little chance the funds can be lost. Many of them will pay a fairly good rate of interest.
More importantly you should be able to access these funds through a debit card. Therefore you can use them to pay bills, cover expenses or invest. This means there is no reason for a person to keep large amounts of actual cash around. There many excellent liquid investments anybody can access.
Even though cash can be a good investment you should limit how much you keep available. You should set a limit of funds you will hold in your cash reserve. If the funds rise above that you should reinvest it in a tax-deferred vehicle such as an IRA, an annuity or an insurance policy.
Persons over 59½ years old should also seriously consider using an insurance policy as a cash reserve because funds in one are tax deferred. Younger people should avoid this because of the tax penalties the IRS puts on retirement investments.