Cash is an important part of my investment strategy. Even inside my Roth IRA, where I hold a mix of stocks, bond funds, precious metals, and crypto, I always keep a healthy amount of cash.

Cash provides flexibility and stability and can also provide interest income.

But cash isn’t a single investment. So invariably, the question becomes:

“What’s the best way to invest my cash?

I want to earn interest without taking on a lot of risk.”

Although there are a lot of conservative bond funds out there, I don’t really consider those to be cash-like investment.

When it comes to the cash part of my investment accounts, there are three options that I generally consider. They are:

We’ll examine each option in turn—and add some bonus commentary on high-yield accounts and taxes.

A money market fund is a mutual fund that holds high-quality, short-term debt investments.¹

Money market mutual funds come in four different flavors:

A money market mutual fund is great because you don’t have to manage the investment. You can choose to have your dividends automatically reinvested in the fund, and then it becomes largely hands-off. That said, it is good to check the yield on the fund periodically. Interest rates change over time and you want to make sure you’re earning a competitive return.

Fees on a money market fund range from less than ten basis points (0.10%) to a little over 40 basis points (0.40%). For a commoditized product like this, lower fees are almost always better. The Vanguard Treasury Money Market Fund—ticker VUSXX—is one of the lowest-cost Treasury-only funds. Schwab and Fidelity offer their own versions of Treasury-only funds—tickers SNSXX and FDLXX, respectively. As of this writing, both the Fidelity and Schwab versions carry higher fees.

One thing that gives me pause about a money market fund is that it can be hard to get your money out in the event of crisis.

Under normal circumstances, you can get your money out of a money market fund on any given business day, or on the next business day, depending on what time you sell your fund shares.

But if there is a financial crisis, the mutual fund company can impose liquidity fees on certain funds, which means you might be able to get your money out—but only if you pay a fee.

And since 2023, the Securities and Exchange Commission (the “SEC”) has allowed certain money market funds to use “share cancellation” during a negative interest-rate environment. If negative rates push a fund’s yield below zero, the fund can keep its share price stable at $1 by reducing the number of shares you own. In other words, if you pay $100 to buy 100 shares of a money market fund today, it is possible that you’ll wake up one day to find that you own 95 shares, worth $95—not the $100 you thought you had.²

In short, money market mutual funds are one of the most convenient ways to invest cash. The vast majority of the time, these funds are pretty low-risk. That said, they can freeze up in the event of economic crisis.

A certificate of deposit or “CD” is a contract with a bank. You give the bank money for a fixed amount of time—three months, six months, one year, or beyond—and the bank pays you interest. A CD is essentially an IOU from the issuing bank.

Money market funds are more convenient than CDs because you buy the fund once and your money stays invested. When you invest your cash in a CD, you have to remember to buy a new CD when your existing CD expires; if you forget, then your cash sits around and potentially doesn’t earn as much interest as it otherwise could. Fortunately, many brokerage firms like Schwab and Fidelity offer an auto-reinvest feature for CDs.

Banks and brokerage firms typically don’t charge any fees or commissions on CDs. But one big exception is if you try to sell your CD before its term is up. For example, if you buy a three-month CD and then sell it two months into its term, you might have to pay a brokerage commission and also may receive less than you originally paid for the CD. So, barring an urgent need for the cash, it’s generally best to keep your money in the CD for the full term (three months, in this example).

CDs can also provide a backdoor into more FDIC insurance.

Here’s how it works:

So, if FDIC insurance limits are a concern, CDs can be helpful.

In short, CDs are slightly less convenient than money market funds. But a CD could be considered a cleaner product than a money market fund because a CD is a direct contract between you and the issuing bank. Interest rates on longer-term CDs can also be a bit higher than on a money market fund, but the trade-off is that your money is typically locked up for the term of the CD.

The U.S. government borrows a lot of money, and it pays interest to the people and institutions that lend to it. You and I are lending money to the government when we buy T-bills.

Much like a CD, a Treasury bill matures, or comes due, at various intervals. T-bills are offered with terms of four, six, eight, 13, 17, 26, or 52 weeks.

Like a CD, when your current Treasury bill matures, you have to go out and purchase another bill; if you don’t proactively reinvest your cash, then you could be missing out on interest that you would otherwise be earning. Fortunately, like with CDs, most brokerage firms offer an auto-reinvest option for T-bills.

In terms of interest, Treasury bills don’t actually make periodic interest payments. Instead, you receive a discount. For example, you might buy a four-week Treasury bill for $995. Four weeks later, when the Treasury bill matures, the U.S. government will pay you $1,000. The $5 discount on the bill is your interest payment, even though it comes in the form of a reduced purchase price.

Finally, Treasury bills are considered securities, so they are protected by SIPC, but not by FDIC insurance.

So far, we’ve focused on some investment options for the cash inside your investment account—a brokerage account or retirement account.

But a high-yield checking account, savings account, or money market account can also be a great home for cash and short-term savings. For example, maybe you have an emergency savings fund. Or maybe you’re self-employed and set aside money to cover your quarterly income taxes. Or maybe you’re saving for an upcoming purchase.

In a high-yield account, you earn interest without having to worry about investing the money into a money market fund, CD, T-bill, or anything else.

The catch is that banks and financial institutions often advertise a high introductory interest rate to lure you in and then reduce that interest rate later on. Periodically, it pays to keep an eye on the yield you’re earning inside your account—to make sure it’s actually high-yield, as advertised.

Dividends on a money market fund are taxed at your normal federal income tax rate. You’ll also pay state and local income tax on that payment if you live in a state or municipality that has an income tax.³

Interest on a CD is also taxed at your normal federal income tax rate. You’ll also pay state and local income tax on that interest if you live in a state or municipality that has an income tax.

Interest on a Treasury bill (i.e., the discount) is generally taxed at your normal federal income tax rate. State and local governments do not collect income taxes on your Treasury bill interest.

Personally, I invest the cash portion of my investment accounts in Treasury-only money market mutual funds—despite the risk of freeze/loss/etc. in the event of financial crisis.

And like many people who are self-employed, I use a high-yield checking account for my income tax reserves.

1

A money market fund is distinct from a money market account (a.k.a., a money market deposit account). The money market fund is a mutual fund investment, whereas the money market account is like a savings account that pays interest.

2

Money market funds are considered securities, and they are protected by the Securities Investor Protection Corporation (“SIPC”). SIPC protects you if your brokerage firm fails, but it doesn’t protect the actual market value of your fund shares.

3

That said—depending on the fund and on the laws of your state—the part of the dividend that is attributable directly to Treasury bills may not be subject to state and local income tax. It’s a minor point, but it could be helpful.