Concepts in this lesson
- Treasury bill
- A US government loan of a year or less, sold below face value and repaid at face value.
- Money market fund
- A fund of very short-term, high-quality debt such as T-bills, paying near short-term rates; not a bank deposit.
- GIC (guaranteed investment certificate)
- A Canadian fixed-term deposit at a set rate, usually locked in until maturity; a US certificate of deposit is similar.
01The four forms of cash
- Bank deposits. Savings and high-interest savings accounts: money you can withdraw any day, paying a rate the bank can change.
- Treasury bills. Short loans to the US government, a year or less. Canada's government sells its own T-bills too.
- Money market funds. Funds that hold T-bills and other short, high-quality IOUs and pass the interest on to you.
- GICs and CDs. Deposits locked for a set term at a set rate: guaranteed investment certificates in Canada, certificates of deposit in the US. A higher rate is usually the reward for locking your money up longer.
All four share two traits: the amount you put in doesn't fall in value, and you know today's rate (a locked term keeps it; an account or fund pays whatever next month's rate is). That is why investors treat cash as the baseline every other investment has to beat.
Cash has a job: the money you'll need soon, or on a date you can't move. Next year's tuition, a new roof, six months of bills in case of a job loss. For that money, the stock market's swings are the real risk, and cash is the only chip whose value you know on the day you need it. The cost described below is the price of that certainty, worth paying on the money that needs it, not on money you won't touch for decades.
02How a T-bill pays
A T-bill pays no coupon. You buy it below its face value and get the full face value back when it matures. The difference is your interest.
You pay $99.00 for a bill that repays $100.00 in 91 days. You earn $1.00 on $99.00, or 1.01% over the 13 weeks. Over a year that works out to about 4.05% (1.01% × 365 ÷ 91).
Treasury's auction results show a bill two ways: a "discount rate" (here 3.96%), worked on the $100 face value and a 360-day year, and an "investment rate" (4.05%), worked on the price you pay. Compare investments using the investment rate.
Our 3-month Treasury bill report shows five years of the yield, and how closely it has followed the Federal Reserve's rate.
03Where the rate comes from
Cash rates follow the central bank. When the Federal Reserve or the Bank of Canada raises its policy rate, T-bill yields and money market fund yields follow within weeks, and banks raise savings and GIC rates, usually more slowly. When the central bank cuts, cash rates fall with it.
That means a cash rate you see today is not locked in unless you lock it: a savings account or money market fund pays whatever the going rate is next month. A GIC or a longer T-bill fixes the rate for its term. See the policy rates on our Economic Indicators pages.
04How safe is safe?
- Insured deposits. In the US, the FDIC insures bank deposits up to $250,000 per depositor, per insured bank, per ownership category. In Canada, CDIC insures eligible deposits, GICs included, up to $100,000 per category at each member institution.
- T-bills are backed by the government that issued them. The US and Canada borrow in their own currencies, so they are treated as the market's benchmark for no default risk.
- Money market funds hold safe, short IOUs, but they are investments, not deposits: they are not covered by deposit insurance. (A bank's "money market account" is a deposit, and is insured; the similar-sounding money market fund is not.)
When finance calls a T-bill "risk-free", it means free of default risk over its short life. It does not mean free of the risk that matters most to cash over time.
05The real return
Inflation is that risk. If cash earns 4% and prices rise 3%, your money buys only about 1% more a year. That is the real return: the interest rate after inflation.
At 4% interest the balance grows to $14,802, worth $11,014 in today's dollars: a real return of 0.97% a year.
At 2% interest the balance grows to $12,190, but it buys only what $9,070 buys today. The account shows a gain; your buying power fell by 9%.
Our CPI page tracks US inflation month by month.
Cash is the chips you keep in your stack instead of putting in the pot. Nobody can take them from you in a hand. But the blinds keep coming around, and a player who only ever folds watches the stack shrink anyway. Inflation is the blinds. You pay them to stay in the game; you don't sit out every hand to avoid them, and you don't shove your whole stack in either.
06What can go wrong
- Inflation above the interest rate shrinks buying power, steadily and quietly.
- Falling rates. A savings account or money market fund pays less as soon as the central bank cuts; only a locked term keeps the old rate.
- Locked money. Many GICs can't be cashed before the term ends, or only with a penalty.
- Uninsured balances. Deposits over the insurance limit, and money market funds, are not covered by deposit insurance.