The concept of cash has evolved significantly over the years. Originally, cash referred only to coins and paper money. However, as financial institutions developed, the definition broadened to include checks, money orders, and even credit. Banks and credit unions profit by borrowing your deposits at low interest rates and lending them at higher rates, a practice known as the net interest margin (NIM).
One of the biggest challenges for banks is maintaining trust. With cash primarily being digital today, people need to trust banks to handle their money responsibly. This trust is tested especially when banks lend significantly more than they hold in deposits, which can lead to problems during financial panics.
Regulatory changes since the financial crisis have mandated higher capital ratios for banks, which has reduced their profitability. This has had several consequences, including lower salaries for finance sector employees and less favorable conditions for small businesses and homeowners.
There’s a common misconception about what cash is, particularly concerning Certificates of Deposit (CDs). Many think of CDs as cash because they are stable and backed by FDIC insurance up to certain limits, but they’re actually more akin to U.S. Treasury bonds because of their safety and return characteristics. Unlike cash, which is meant for immediate transactions, CDs are better compared to bonds due to their investment nature.
It’s crucial not to dilute the definition of cash. Tools and apps that manage personal finances should only classify liquid assets like savings and checking accounts as cash. Anything else, including CDs, should be considered investments due to their potential penalties and lock-in periods.
To effectively manage finances, it’s important to accurately track and categorize financial resources. Only by understanding the true nature of each financial instrument can individuals make informed decisions and optimize their financial health. In essence, while cash might seem like a simple concept, its role and definition in financial management are nuanced and critically important for personal finance.
