If you're going to need money in the near future, temporary investments are the most sensible place to put those dollars. In the parlance of the investment community, temporary investments are called "cash equivalents" or just plain "cash." Others may refer to them as "short-term investments." Whatever they're called, these are very safe investments that can easily be converted into cash. The price you pay for safety and liquidity is a lower rate of return than bonds and other longer-term investments. And while cash equivalent investments hardly offer breathtaking returns, you might as well earn as much as you can on them.
When cash is a sensible investment. While you benefit from taking a long-term view when selecting and managing your investments, there are times when you need to be assured you can tap into some money in just a few months or in a year or two without risking a large loss in principal. There are several reasons why you might want to keep some money in cash equivalent investments, including:
- To meet foreseeable short-term cash needs, like college tuition, home improvements, a first or second home purchase, or another big ticket item.
- To keep some money on the sidelines in case an interesting investment opportunity arises.
- To gradually invest a substantial amount of money resulting from a financial windfall – an inheritance, for example. In other words, rather than investing the money all at once, which could be a risky proposition, it would be put into cash and gradually moved into greener pastures.
- To temporarily take some money off the stock and bond table if the markets are causing you to lose sleep. (But deviating from your sensible investment plan is a risky response to a troubling market.)
- When you retire, you might also want to switch some of your retirement investments into cash in order to assure being able to meet your living expenses over the ensuing six months or year, without having to sell into a down market.straightforward. With a little bit of effort, however, you can make the most of these otherwise mundane investments.
The keys to maximizing the interest you'll receive are:
- Ascertaining the current average interest rates and top yielding interest rates paid by various categories of temporary investments. This information can be found easily by accessing any number of web sites that show average and top yielding interest rates. Also, the financial pages of most newspapers regularly show the interest being paid on most types of temporary investments, including rates offered by local banks. Now this may strike you as a time-consuming process that will only net you a few cents more interest. Not so. You can substantially increase your temporary investment interest and, over the years, that can add up.
- Comparing after-tax yields to find the temporary investment with the best return - after taxes are taken out. Once you've determined the interest that's being paid on the various temporary investments, the next step is to find out which pays the most after taxes are factored in, assuming, as is usually the case, the temporary investments are being held in a taxable account. If they're being held in a retirement account, taxes don't matter (yet), so pick the temporary investment with the highest yield. The trick here is simply to do some ciphering to determine how much taxes would reduce the investment return, based on your tax bracket. Even though the stated interest rate on a particular cash equivalent investment may be lower, it's how much you get to keep after taxes that counts.
Here are a few other suggestions to help you make the most from your temporary investments:
- If you're in the market for a CD, a little shopping around-even outside your hometown-could reap rewards. First compare rates among banks in town; banks are in hot competition with each other. If you have a broker, check with him or her about CD offerings that the brokerage firm may have. Finally, check the web sites mentioned above for the highest yielding CDs in the country. Remember, as long as the issuing bank is FDIC insured, you really shouldn't care where your CD comes from. You just want the best yield, although if your own bank offers something close to the best yield you might opt for it rather than some far off bank.
- If you have an account with a mutual fund or a broker offering several different kinds of money market funds, be sure to compare yields to make sure the one you select offers the best after-tax return. This may require you to periodically compare the returns among various money market funds, but, what the hey, if you can improve your return by periodically switching among money market funds, it's more money in your pocket.