Every MoneySense investor should understand there are times when cash isn’t trash. In fact, there are times when cash can glitter, saving you from market or personal disaster.
Besides the relatively rare periods when cash has actually been the best performing asset—better than stocks or bonds—always having some cash on hand can ensure that you can preserve an investment plan or avoid paying interest on a credit card because you can’t pay off a monthly card bill.
Why is this important?
Some people making progress in reaching their financial independence goals are actually quite vulnerable—they are cash poor. And their investment progress could come to a halt because they suddenly are cash poor and have to make difficult moves. These moves might include having to sell winning investment prematurely.
Todd Ericson, an Overland Park, Kansas advisor, says it is important to anticipate potential cash problems.
“Prior to each quarterly meeting we ask our clients to give us their current bank balances. We then determine if they will need additional cash from their portfolio, and if so, develop a plan to make sure our clients have the cash they need when they need it,” he says.
How does one balance the goals of growth with the need to have enough cash on hand to handle periodic emergencies and what is the best way to hold the cash component?
A Year of Cash in Reserve
Ericson says the goal is to ensure that clients have access to 12 months’ worth of cash so there will be no need “to sell securities during a dip in the market.” The cash component of the portfolio, he adds, should be discussed at every scheduled client meeting.
Where should the cash be stored?
“I use money market mutual funds and/or short-term bond funds. This gives some yield on the money but also provides the stability you’re looking for from a cash investment,” says Edward Snyder, an advisor in Carmel, Indiana.
Michelle Buonincontri, an Anthem, Arizona advisor, says “for those with access to the TSP (Thrift savings plan) the G fund makes a great cash component of a retirement account, as it is guaranteed, with an interest rate equivalent to a long-term security.” She said it was recently yielding 2.25%.
Cash is not a component of the portfolios managed by David Bize, an Oklahoma City advisor. However, he “ensures that the client has sufficient “emergency cash reserves” and/or sufficient cash flow from earnings, pensions, Social Security, etc., for applicable timeframe.
He says his client portfolios are “fully invested without “cash.” Bize uses using money markets funds paying 1.9% or better as “emergency cash reserves.”
Cash and Inflation
But William Jerome, an advisor in Scotia, New York, says some clients have large amounts of cash in very low paying money market accounts and think they’re getting a good deal but they are not.
“I have to tell them that with inflation they are actually losing money,” Jerome says. He says there’s a better way of keeping some cash on hand: Jerome stashes cash in short-term ETF bond funds that pay about three percent.
“You can use a low-cost broker and you’ll have the money within a day,” he says.
Jerome, who also doesn’t like to count cash as part of a portfolio, says some clients simply want to keep $10,000 to $15,000 on hand against emergency situations.
However, despite the pathetic performance of cash over the last few years, there is a case that can be made for this “trashy asset” besides avoiding client cash shortages.
Cash, the Best Performing Asset?
There are still periods, even as long as a decade, when cash is a better investment than stocks, according to a LendingTree.com study. In a recent 51-year period cash was the best performing asset 30 percent of the time, the study found.
Hard times for stocks often mean all that glitters are not financial assets, but garden variety cash, such as certificates of deposit (CDs).
“Unsurprisingly, CDs outperform stocks more often during economic recessions and under-perform during economic expansion, although there are pockets of exceptions,” according to the study.
Indeed, Anthony Ogorek, an advisor in Buffalo, New York, believes clients should have cash and for various reasons.
“There’s a time and a place for every asset class, especially one that is much less expensive than alternative assets,” according to Ogorek.
Ogorek, who uses short term treasury bills as his cash portfolio diversifier, sometimes opts for cash. That’s because, he adds, it “is much less opaque than other assets. And because cash is highly liquid, it can be a relatively attractive asset for a small number of clients.”
How Much Cash?
He says that in some of his client’s cash is about five percent of the portfolio. Besides the conservative client who wants to preserve wealth, cash can also make sense for the younger client when stocks are smelling up the investment world, according to Ogorek.
Then you can use some of your cash reserve to take advantage of sudden investment opportunities, he says.
The author of the Lending Tree study also said it is important to remind investors that over relying on any one asset class, such as equities, is dangerous.
“We did this study as a wake-up call to make people understand that one needs more than just stocks and bonds as a diversifier; that stocks and bonds can sometimes go down together as in 2008,” according to Brian Karimzad, vice president of research for MagnifyMoney, a LendingTree subsidiary.
He added that, for the average investor, cash as a part of a properly diversified portfolio can be important for a number of reasons. A cash reserve can be critical in hard times; when someone has lost a job.
He added that “now that brokerage houses are paying next to nothing on cash as a way to offset the cost of commission less trades, it is more important than ever to seek out non-sweep money fund alternatives.”
Cash, Ogorek added, can also be an effective investment for when equities are cheaply priced and the client can take advantage of it.
And cash can also save you when stocks are pricey, Karimzad said.
For instance, six-month certificates of deposit, the study said, did very well at the beginning of the period known as the lost decade. That’s when CDs had the longest time of beating stocks, a 33-month period from 2000-2003.
“The 1-year return of 6-month CDs beat the 1-year return of stocks for 33-consecutive months,” according to the study.
That’s almost three years when stocks were anything but “trash.” To rephrase the Bard of Avon, all that glitters is not equities, often you have heard this told.
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