Near money

3 key takeaways

• Near money assets are highly liquid financial instruments that can be quickly converted into cash with minimal loss of value.
• Examples of near money include savings accounts, certificates of deposit (CDs), Treasury bills, and money market funds.
• Near money plays a crucial role in financial planning and liquidity management, offering a balance between earning a return and maintaining liquidity.

What is near money?

Near money, also known as quasi-money, consists of assets that are close substitutes for cash. These assets can be converted into cash quickly and without significant loss in value, making them useful for managing short-term liquidity needs. Near money is not included in the narrow definition of money (M1), which includes physical currency and demand deposits, but is part of broader money supply measures like M2.

Key characteristics

• High liquidity: Near money can be easily converted to cash.
• Low risk: These assets typically carry low risk compared to other investments.
• Interest-bearing: Near money often earns interest, providing a return while maintaining liquidity.

Importance of near money

Liquidity management

Near money assets help individuals and businesses manage liquidity by providing a readily available source of funds to meet immediate financial obligations.

Financial planning

Including near money in a financial portfolio offers a balance between earning a return and maintaining liquidity, essential for effective financial planning.

Economic stability

Near money assets contribute to the stability of the financial system by ensuring that funds are available to meet short-term demands, reducing the risk of liquidity crises.

Key examples of near money

Savings accounts

Savings accounts are interest-bearing deposits at banks or other financial institutions. They are highly liquid and can be quickly converted to cash with minimal penalties or restrictions.

Certificates of deposit (CDs)

CDs are time deposits offered by banks with a fixed maturity date and interest rate. While they are less liquid than savings accounts, they can be converted to cash relatively quickly, often with a penalty for early withdrawal.

Treasury bills (T-bills)

T-bills are short-term government securities with maturities ranging from a few days to one year. They are highly liquid and considered very safe, as they are backed by the government.

Money market funds

Money market funds are mutual funds that invest in short-term, high-quality, liquid assets such as T-bills and commercial paper. They offer higher returns than savings accounts while maintaining high liquidity.

Commercial paper

Commercial paper is a short-term, unsecured promissory note issued by large corporations to meet short-term financing needs. It is highly liquid and typically offers higher returns than government securities.

Benefits of near money

Flexibility

Near money assets provide flexibility by allowing individuals and businesses to access funds quickly without incurring significant losses, making them ideal for managing unexpected expenses or opportunities.

Safety

Most near money assets are low-risk, providing a safe place to park funds while earning a return. This makes them attractive for risk-averse investors.

Income generation

Near money assets often pay interest, providing a source of income while maintaining liquidity. This makes them a useful component of a diversified financial portfolio.

Drawbacks of near money

Lower returns

Near money assets typically offer lower returns compared to longer-term investments like stocks or bonds. This trade-off is due to the higher liquidity and lower risk associated with near money.

Inflation risk

The returns on near money assets may not keep pace with inflation, potentially eroding purchasing power over time. Investors need to balance the need for liquidity with the risk of inflation.

Limited growth potential

Near money assets do not provide the same growth potential as more volatile investments. They are primarily used for liquidity management rather than long-term growth.

Example of near money in practice

Emergency fund

An individual may keep a portion of their savings in near money assets as part of an emergency fund. This ensures they have quick access to funds in case of unexpected expenses, such as medical emergencies or job loss, while still earning some interest on their savings.

Corporate treasury management

A corporation might invest excess cash in near money assets to manage liquidity. This allows the company to meet short-term obligations, such as payroll and supplier payments, while maximizing the return on idle cash.

Conclusion

Near money plays a crucial role in financial planning and liquidity management. These highly liquid assets provide a balance between earning a return and maintaining quick access to funds. By including near money in a financial portfolio, individuals and businesses can effectively manage short-term financial needs and enhance overall financial stability.

Related Topics:

• Money supply
• Liquidity management
• Financial planning
• Treasury bills
• Money market funds

Exploring these topics will provide a deeper understanding of the role of near money in the broader financial system, its benefits and limitations, and its importance in effective financial management and planning.