Different forms of cash
Cash-based investment products – such as term deposits or money market funds – are widely considered to carry a low amount of financial risk. There is typically a trade of between risk and return (meaning returns can be low) but the money can usually be accessed quickly and the risk of getting back less than invested is usually very low.
Money market funds invest in a wide variety of products that mature in very short periods of time and can include short-term loans by governments, banks and companies with very high credit ratings. Typically, money market funds have very low risk and return slightly more than a bank deposit.
Breaking the buck
In times of extreme financial trouble, cash-based investment products can lose money.
In September 2008 (during the global financial crisis), Reuters reported that The Reserve Primary Fund, a large US money market mutual fund, could not guarantee that investors would receive all of the money they had invested. The fund had loans outstanding to collapsed financial services firm Lehman Brothers, causing problems with repayments. As money market investors would not receive at least one dollar for every dollar invested, the fund was said to have “broken the buck”. This time, however, the US Department of the Treasury stepped in to ensure investors did not make losses.
US regulators in February 2012 proposed changes to the rules governing money market funds. However, these changes are controversial as some argue that the changes will not guarantee investors will get all of their money returned in the future.
In times of financial crisis, even deposits at banks can be at risk if banks fail. In many countries, deposits at banks are guaranteed up to a certain amount. It makes good financial sense for those with large amounts of cash, perhaps from a sudden windfall or from selling a house, to check that the amount of cash they hold does not exceed the guarantee limit.
Keep an eye on fees
When interest rates on cash and very short-term investments are very low, it is particularly important to watch fees charged by money market funds. This is because the fees could end up being higher than interest rates.
Inflation can also take a toll when returns are very low, eating away at purchasing power, as an eZonomics video on protecting savings from inflation explains.