The Retirement Corporation of America

Reviewing The World Of Cash

HERE'S THE "60-SECOND" lesson about cash:

•  Nature of the investment: Cash is money that is usually invested for only weeks or months, but occasionally for more than a year. Money in a bank CD is cash. Money invested in a short-term Treasury security is cash. Money in a money market mutual fund (which invests in very short-term securities) is cash.

•  Risk: Very low to risk-free.

•  Reward: Very low to low.

•  Role in your retirement savings: As a place to put money that is waiting to be invested in stocks or bonds. As a place to hold money you have taken out of the stock or bond markets because you believe they are too volatile right now.

Understanding the Nature of Cash

To understand why cash is such a high-safety, low-return investment, you need to understand the nature of both risk and volatility:

•  Because the life span of a cash investment is short, the risk of your money not being there when you want it is very low. Far fewer things can go wrong with an investment in three months than in 30 years. You can reduce the risk to virtually zero by holding cash in an insured bank account or CD.

•  Because the life span of a cash investment is short, it isn't subject to as much volatility. There's not much point in bidding the price of a three-month Treasury bill up or down, when its life will expire in 90 days and you'll have all your cash in hand again. You can reduce the volatility to zero by investing cash in a bank CD where there are no market fluctuations.

Which Cash Investment Should You Choose?

You could buy a U.S. Treasury bill (or T-bill)—backed by the might and majesty of the United States of America. Any broker could buy a T-bill for you, or you could buy one directly from Uncle Sam through the Treasury Direct program described on Page 14. Still, most individual investors will opt for either a bank CD or a money market mutual fund.

•  The odds favor a CD when interest rates are falling. You always earn the same fixed rate no matter how low the rates fall. The yield on your money market mutual fund will fall along with market rates.

•  The odds favor a money market mutual fund when interest rates are rising. Your yield will rise along with market rates. The rate on the CD will stay fixed no matter how high interest rates go.

Remember you always have immediate access to your money in a money market mutual fund, but must wait until the CD matures to get all your money—an early withdrawal is penalized.

All things being equal:

•  Favor a CD if you will need the money on a certain day within the next year, and you don't see a dramatic rise in interest rates on the immediate horizon.

•  Otherwise, favor a money market mutual fund for its flexibility and the immediate access to your money it offers—if you don't see a dramatic fall in interest rates on the immediate horizon.

Summing up cash: Stocks are very volatile, and bonds can sometimes be volatile, too. You add cash to the mix of stocks and bonds so that part of your nest egg is invested in areas that aren't volatile at all. Don't overdo your use of cash, because the return is so low. But don't ignore it either, because the volatility and risk factors are much less than stocks and bonds.