One of the biggest questions investors face is, “what do I do with my cash when I’m in-between investments?”. This article seeks to examine two of the most popular choices – certificates of deposits and money markets – and weighs the pros and cons of each.
In the left corner: certificates of deposit
Certificates of deposit (or CDs for short) are debt instruments issued by banks and other financial institutions to investors. In exchange for lending the institution money for a predetermined length of time, the investor is paid a set rate of interest. Maturities on certificates of deposit can range from only a few weeks to several years with the interest rate earned by the investor increasing in proportion to the time his capital is tied up in the investment.
Pros: The investor can calculate his expected earnings at the outset of the investment. Certificates of deposited are FDIC insured for up to $100,000 and offer an easy solution for the elderly who desire only to maintain their capital for the remainder of their life.
Cons: If the investor opts for a longer maturity and, thus, higher rate of interest, he will lose access to his funds and forgo alternative uses of his capital.
In the right corner: money markets
Money markets, on the other hand, offer many of the same benefits as certificates of deposit with the added features of a checking account. Technically speaking, a money market is more or less a mutual fund that attempts to keep its share price at a constant $1. Professional money managers will take the funds deposited in the money market and invest them in government t-bills, savings bonds, certificates of deposit, and other safe and conservative financial instruments. This income is then paid out to the owners of the money market.
Investors can open a money market account at most financial institutions. They generally receive a checkbook with which they can draw upon funds in the account.
Pros: Depositing money in a money market is as easy as depositing cash into a savings or checking account. Cash is immediately available for alternative investments.
Cons: Some financial institutions place a limit on the number of checks that can be drawn against the account in any given month. The rate of interest is directly proportional to the investor’s level of deposited assets, not to maturity as is the case with certificates of deposit. Hence, money markets are disproportionately beneficial to wealthier investors.
Although both can be useful, for those who need access to their capital, money markets are far superior. Many brokerage houses automatically sweep their customer’s uninvested cash into money markets to earn interest between investments. This is the ideal solution if you regularly invest because the funds can be used immediately to purchase stocks, bonds, or mutual funds.