What are cash equivalents, and should you be using them?

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When people talk about “cash,” they usually mean the money sitting in their checking account. But in personal finance, cash often includes more than just dollars you can spend today. That’s where cash equivalents come in.

These low-risk, highly liquid financial products are designed to hold your money safely while keeping it easily accessible. And often, they earn more interest than a traditional checking account.

Understanding what qualifies as a cash equivalent can help you make smarter decisions about where to park your emergency fund, short-term savings, or any other money you may need soon.

Cash equivalents are highly liquid assets you can convert into cash quickly, without penalty. However, with high liquidity often comes modest growth. Cash equivalents typically earn lower interest compared to higher-earning asset classes, such as stocks. On the plus side, their value doesn’t fluctuate much, which can help to stabilize your portfolio.

A key characteristic of cash equivalents is their short maturities of three months or less. While these assets aren’t immediately available, they still offer flexibility when it comes to short-term financial obligations.

You often see cash equivalents lumped in with cash, but they’re not the same. While it can sometimes be useful to group them together, there are key differences between these two asset classes.

Cash includes physical currency and money in demand deposit accounts (such as checking and savings accounts). It’s money you have immediate access to without needing to make any conversions. In other words, it’s ready to spend.

Cash equivalents, on the other hand, are financial products that function almost like cash but may require a small extra step to access. They’re highly liquid, low risk, and designed to maintain a stable value.

Generally, cash equivalents are assets you can liquidate within three months or less.

Here are some examples:

Short-term certificates of deposit (CDs): When you put money into a CD, you can expect to earn fixed interest throughout the CD’s term. However, you generally can’t touch your deposit before maturity without incurring a penalty. Though money in a CD isn’t immediately accessible, short-term CDs with maturities of three months or less are examples of cash equivalents.
Money market funds: Money market funds are a type of mutual fund that invests your money in low-risk, short-term securities. Earnings are modest, like other cash equivalents. However, unlike other mutual funds, money market funds are highly liquid investments.
Treasury Bills or other short-term bonds: Also known as T-Bills, Treasury Bills are short-term government bonds that mature in less than one year. You purchase a T-Bill at a discount, and when it matures, you receive its full face value. Bonds can have a wide range of maturities, but only those with terms of three months or less are considered cash equivalents.

Due to their modest returns, cash equivalents shouldn’t make up your entire portfolio, and other asset types can help you balance growth and risk. The following are not examples of cash equivalents:

Stocks
Bonds with longer maturities
Mutual funds
Exchange-traded funds (ETFs)
Real estate
Retirement accounts such as 401(k)s or IRAs

As mentioned above, cash equivalents are a crucial part of your portfolio. But along with their advantages, there are disadvantages you should understand.

Accessibility: By definition, cash equivalents must be quickly accessible. This makes them ideal for short-term spending goals, such as planning a vacation or paying for a wedding.
Stability: The value of cash equivalents is relatively stable, ensuring your cash will be there when you need it for short-term expenses. Their interest rates don’t fluctuate much and, in some cases, are even fixed.
Security: Having a healthy proportion of cash equivalents in your portfolio gives you a sense of security. If an emergency happens and you need cash within the next few months, you can tap these assets.
Opportunity: Cash and cash equivalents make it possible to jump on opportunities when they arise. Unlike with stocks or other illiquid assets, you don’t have to worry about taking a loss when accessing your money.
Growth: Though cash equivalents aren’t known for high yields, they earn more than cash. For example, CD rates generally outpace savings and checking accounts rates.

Lower yields: Compared to stocks and other higher-risk investments, cash equivalents have much lower returns.
Fees: Some cash equivalents may involve fees or other barriers. For example, CDs charge early withdrawal fees, and money market funds may have high account minimums.
Inflation: When your investments earn modest returns, inflation is a real concern. Inflation erodes the purchasing power of your money over time and can sometimes outpace interest rates.

Examples of cash equivalents include certificates of deposit (CDs), money market funds, Treasury Bills, and other short-term bonds.

Cash is readily available for spending without any need for conversion. Meanwhile, cash equivalents are short-term investments. They may have maturities of up to a few months, in which case you can’t convert them into cash right away.

A cashier’s check is generally considered cash, not a cash equivalent. Cashier’s checks are guaranteed by a bank, making them extremely low-risk. They’re also highly liquid, as you can cash them and access the money immediately. Finally, they’re not an investment, and their value won’t change before they’re cashed.