“Safe as cash in the bank” certainly rings true, especially as the Federal Government guarantees balances of up to $250,000 held by individuals in bank, building society or credit union accounts. A cash investment can generally be made quite easily, with low risk, and your money can usually be accessed with low, or potentially zero, fees applying to withdrawals (except in some cases, for example, early access to term deposits).
Cash-based assets allow investors to benefit from a low risk investment that can also be highly ‘liquid’. In other words, with most types of cash accounts, you can withdraw your money relatively quickly when you need funds with some fee implications for early access.
In the investment world, lower risk generally means lower returns, and the key downside of cash is that your money won’t generate capital growth. So unless you earn more than the rate of inflation, after tax, and reinvest those returns, inflation can steadily lower the purchasing power of your money.
The ongoing returns from cash (in the form of interest income) are relatively low, particularly if you factor in inflation (the ‘real’ return).
In addition, interest income is normally fully taxable, so you could lose a proportion of your interest to the tax man.
The liquidity of cash means it has an important role to play in every portfolio, and for short term goals in particular. However, the lower returns may mean that, for longer term goals, it may be more appropriate to invest in cash as part of a more diversified portfolio, which includes shares, property and fixed interest investments such as bonds.
Not all cash investments are the same. Your choice includes transaction accounts, online savings accounts and term deposits. Let’s see how each of these work.
Transaction accounts are also called “everyday accounts” and just about everyone has one with a bank, credit union or building society. We use them to receive our pay, to take out cash and pay bills but they pay little or no interest and you could also pay ongoing account fees.
The key to transaction accounts is finding one that suits your style of money management.
Most people choose online savings accounts for the convenience. They let you transfer money easily to and from a transaction account to take advantage of their more favourable rate of interest.
The higher rate of interest is usually an incentive to leave your money alone so it can grow through compound interest. Some accounts even reward you with higher interest if you top up the balance regularly or restrict your withdrawals.
Term deposits allow you to invest your money for a fixed term and for a set rate of interest. This type of investment is popular with the more risk averse investor because there's virtually no risk of losing your money and you usually earn a rate of return that's higher than an online savings account – especially for longer terms of, say, five years.
On the flipside, it pays to only lock away money you definitely won’t need until the term expires. Penalty fees may apply if you try to access your money before the term expires.
Next: Managed investments