The term "cash" is used rather loosely.
Sometimes it refers to cold hard cash in your wallet and other times it refers to money
in your checking or savings account.
But when it comes to investing, cash describes an entire asset class.
But what exactly is cash in the investing world?
Cash typically describes funds held in money market accounts, which are relatively low-risk
investments that pay a small amount of interest, usually once per month.
Money markets are highly liquid, meaning you have instant access to your funds.
Some investors use the liquidity of money markets to pay for expenses, while others
might use it to move in and out of investments like stocks or bonds.
Money markets are liquid and low-risk because they invest in short-term debt such as Treasury
bills, commercial paper, and repurchase agreements, among other investments.
That's because most of these investments mature in less than one year, and, on average,
the maturities are as short as 60 days or less.
This means investments are frequently maturing and being replaced to limit exposure to losses.
While these investments are maturing and being replaced, they pay a small interest payment
and offer investors ample liquidity.
Keep in mind these investments are exposed to risks similar to other debt investments
such as changing interest rates.
There are generally two types of money markets: accounts and funds.
Banks and credit unions offer money market accounts and the investing world offers mutual
funds.
In this video we'll focus on money market mutual funds.
Unlike other mutual funds that invest in stocks and bonds and fluctuate in price, certain
money market funds seek to maintain a stable price of $1 per share and pay a small interest
payment once per month.
The interest payments of money market funds are usually a little higher than similar savings
vehicles, such as checking and savings accounts.
But with the money market fund, interest rates are usually variable, which means they might
increase or decrease.
With the slightly higher interest rate comes slightly more risk.
This is an important distinction between money market funds and checking and savings accounts.
Although rare, it's possible to lose money in a money market fund.
Such losses did occur in a few money market funds during the Financial Crisis.
Another aspect that sets money market funds apart from traditional savings accounts is
the management fees.
These fees are assessed in the form of an expense ratio.
And although these fees are small, they're another drawback of money market funds.
There are many types of money market funds, but they're generally divided into two types: taxable
and non-taxable.
Like the labels imply, interest from taxable money market funds are subject to taxes, while
interest from non-taxable funds may be exempt from certain taxes depending on local laws
and individual situations.
Non-taxable money market funds generally invest in short-term municipal securities.
But before investing in a non-taxable money market fund, you'll want to check with your
accountant or state tax authority to make sure the fund you're considering qualifies
for tax exemption.
One place you're likely to find a taxable money market fund is in an employer-sponsored
retirement plan, like a 401(k).
Because these accounts already defer taxes, there's no need for a non-taxable fund within
them.
In a retirement account, a money market fund allows investors to allocate a portion of
their portfolios to the cash asset class.
This can be useful when investors want to move out of riskier assets, such as stocks
and bonds, during volatile times.
The goal of a money market fund is to limit losses and pay a small amount of interest.
However, one drawback of money market funds is that interest paid may not keep pace with
inflation.
This means your cash may lose value.
But, while no investment is 100% safe, money market funds are among the lowest risk investments.