In a continuing effort to help new homeowners set up their budget, I thought it wise to go over the idea of cash. You know what cash is? The stuff that used to be in our wallets? Well, yes, that is one version of cash, but when you are speaking to people in the financial industry cash means a bit more than that definition.
Even with all of the somersaults of the stock market, I still think that you should have a basic portfolio which includes an S&P tracking stock, and a bond fund, like the one from Lehman Brothers. However, you will need to round out your portfolio with cash: CDs; T-bills; and money market mutual fund. When I was buying some CDs, I took my son to the bank with me, because I wanted him to learn about money. I have always involved him in the steps that I am taking. I started when he was young, so I know that he did not have a clear understanding, but at least he has the exposure. I encouraged him to ask questions, so he put this query to the banker: what music is going to be on the CD? He was five at the time. She explained that a CD was a certificate of deposit. It was like giving the bank a loan, so they could loan the money to others. You could pick how long you wanted to loan the bank money. The longer you loan, the higher the interest the bank will pay- that is the money that the bank will pay you. So no Rolling Stones, my son responded. No, she said. Could we loan money to them, he asked. I guess we could, she laughed. Good, my son said satisfied.
A CD is one of the easier ways to have your money in cash, while earning a good interest rate. Here is my method for setting up my CDs. I choose a one year term, which means that at the end of the year, I could take the money out, or I could roll it over for another year in the CD. In this way the money will be available if I need it, but I take this a step further. If the money is available in January, what happens if I need it in June? To resolve this dilemma, I have one CD scheduled to come due in January and one in June. However, I like the idea of having cash ready for each quarter, so I also have CDs coming due in March and September. The minimum amount for all CDs that I am aware of is $1000. With these four CDs, you have close to the basic amount for your emergency fund for your home.
T-bills refers to Treasury bills, which is like loaning money to the Federal government. They work in a similar fashion to CDs. Banks used to sell these bills, but most banks seem to be directing you right to the Treasury Department to buy them. You can do this over the internet now.
Money Market Mutual Funds are offered by firms like Vanguard or Fidelity, so they are not insured by the federal government (the FDIC that you may see posted on your bank’s door). The typically allow you to write some checks against the account, but the idea is to keep the money in the account. These firms do work hard to ensure that your account will not lose money, so they are relatively safe. The money market accounts provided by your bank are similar, but they are not mutual funds. These accounts are insured by the government, but they do not offer as high an interest rate to you.
I hope this gives you an idea of what is meant by cash. I find CDs to be the easiest for me, but all of these means are easy to set up. In our current market, these “cash” vehicles are needed for some stability.