The question of how to invest your cash equivalent assets when you are between longer term investments is always a debacle.
Read on to learn more about the strengths and weaknesses of CDs and Money Market investments!
Certificates of Deposit (CDs) – CDs are debt instruments that banks and other financial institutions issue. You receive a set interest rate in exchange for depositing your money for a set period of time. CD maturities range from several weeks to as much as several years. The interest rate you receive is higher the longer the maturity period.
Strengths – You know exactly how much interest you will earn!
The FDIC insures CDs up to $100,000, which makes them a great alternative for older people who need to maintain capital for an unknown future period of time and can not afford high risk investment options.
Weaknesses – The primary drawback to certificates of deposit is opportunity risk. Especially with longer maturity CDs, your risk that interest rates increase during the maturity period means that you could miss out on other, higher return opportunities.
Money Market Accounts – With money market investments, you have some of the benefits of certificates of deposit and some features of a checking or savings account.
A money market fund is, in effect, a mutual fund with share prices made constant $1 each. The money managers invest the funds in low-risk investments like government t-bills, savings bonds, CDs, and other financial instruments that are all conservative in nature. Shareholders receive the income.
Most financial institutions offer money market accounts. In most cases, you get a checkbook to use when you wish to withdraw funds.
Strengths – Using a money market account is as simple as making deposits to a checking or savings account. Your cash is very liquid.
Weaknesses – There may be a limit on how many checks you can draw against your money market account per month. Interest rates very with the yields of the underlying investments made by the money managers and there is no additional interest received if you leave the funds in your account for longer or shorter periods.
Either of these cash alternative investments are a good choice. Depending on the interest rate differential, in most cases financial experts advise the use of money market accounts for more flexibility, unless economic conditions are such that a good premium is offered on certificates of deposit.