Making Your Savings Decisions

Savings Instruments

There are many different ways to save your money until you use it. The primary difference is the level of liquidity. Liquidity refers to how easy it is to turn an asset into cash without losing value.

Liquid Asset Examples

• Cash (on hand) and cash equivalents
  
  
  • Cash equivalents: Low-risk, near-cash items that can quickly be converted into cash (e.g., checking account and savings account)
    
    
• Securities: CDs, Money Market Mutual Funds (MMMFs), bonds, stocks

Non-liquid Asset Examples

• Real estate
  
  
• Vehicles
  
  
• Jewelry
  
  
• Collections of valuable items

Liquidity and return are negatively related, which means you face a trade-off. If you want a higher return, you must give up more liquidity and risk being short of cash. Your choice of saving instruments should reflect your liquidity needs.

Savings Instrument Examples

Checking account

• It is complete liquidity.
  
  
• It is a demand deposit (meaning money is available anytime on demand).
  
  
• It typically earns no interest.
  
  
• It is used for daily spending and is not suitable for savings.
  
  
• FYI: Some checking accounts offer extremely low interest but often require a minimum balance and have slightly lower liquidity than checking accounts with no interest.

Savings Account

• Less liquid than a checking account, but still very liquid.
  
  
• It is a time deposit (the intent is for the money to stay on deposit).
  
  
• It offers minimal interest or a bit more interest with a minimum deposit requirement.
  
  
• It is the simplest way to save money.

Certificates of Deposit (CDs)

• Less liquid than a traditional savings account.
  
  
• They are a fixed-time deposit.
  
  
• They offer higher returns than a savings account.
  
  
• They are purchased in a specified dollar amount at a specified interest rate and are expected to stay on deposit for the specified period.
  
  
  • CDs have different maturities (six months to five years).
    
    
  • There is a penalty for early withdrawal.
    
    
• They are a good saving option if you are willing to give up more liquidity.

Money Market Mutual Funds (MMMFs)

• Low risk investment.
  
  
• Higher returns than CDs.
  
  
• Invest in high-quality securities that have a short-term maturity.
  
  
• Maturity: typically less than 90 days.
  
  
  • Invest in short-term government debt (also called treasury bills or T-bills).
    
    
  • Invest in commercial paper (short-term debt issued by large corporations).