How to Cash In On These Uncertain Times
NEW YORK ( TheStreet) -- In uncertain times -- and these times certainly qualify -- cash is king. But "cash" takes many forms, from checking accounts to money markets to bond funds, and some are more cash-like than others. So which option is best?
That depends on how you weigh a variety of factors, from accessibility to safety and the importance of yield, according to an analysis by The Vanguard Group, the mutual fund giant. In fact, a single investor may have several forms of cash, each for a different purpose.
"The type of investment selected will depend on the investor's particular needs, with safety and liquidity the top concerns," Vanguard says. "Two often-recognized downsides of holding cash are, first, that the money earns very little yield, and, second, that it remains subject to inflation risk."
That means the interest earnings are too small to offset the dollar's gradually declining purchasing power. On the other hand, in most forms cash is fairly well protected from the deep losses investors can suffer with stocks and bonds. Cash holdings are therefore ideal for next week's groceries, next month's mortgage payment and the rainy-day fund. Cash is also useful for holding money that could be put later into a riskier but potentially more profitable investment such as stocks, bonds or real estate when the opportunity arises.For immediate needs such as ordinary bills and emergency reserves, Vanguard recommends true cash holdings: money market funds and accounts, checking accounts, savings accounts and short-term Treasury bills, or mutual funds containing them. These bills are U.S. government bonds issued in maturities of four to 52 weeks. (At maturity you get your principal back, and you can sell the bond before it matures.) All these options offer quick and easy access, and all are quite safe. Bank accounts are federally insured against loss. Money market funds at mutual fund companies and brokerages are not insured but have an excellent safety record. Treasury bills are not insured but are solid because of the government's good credit. Unlike bonds with longer maturities, Treasury bills, especially if they have short maturities, are not subject to big losses when interest rates rise, since investors do not have to live with the older, lower rates for very long. Many investors also use cash-like holdings to reduce the risk of their portfolios overall, since these holdings are less volatile than stocks or long-term bonds. Since this type of "cash" is not for immediate expenses and emergencies, investors can afford to tie it up longer in holdings that typically produce higher yields than true cash. This category includes Treasury bills with longer maturities, such as 52 weeks, certificates of deposit, bonds issued by U.S. government agencies, corporate bonds, municipal bonds and short-duration bond funds. A five-year certificate of deposit, for example, yields about 0.88%, compared with 0.08% in a savings account. Another key consideration is fees and commissions, which can chew up the interest earnings on cash vehicles, especially when yields are as low as they are today. Vanguard says investors who can afford to tie up their cash should consider laddering, or investing in vehicles with various maturities. Those with longer terms will yield more, while short-term vehicles will be accessible and provide funds to invest in higher-yielding holdings if conditions change. An investor with $25,000, for example, might put $5,000 each in one-, two-, three-, four- and five-year certificates of deposit. After a year, each CD's maturity would be one-year shorter, and the cash in the one-year CD would be available for spending or to invest in a new five-year CD. For a breakdown on the pros and cons of each type of cash holding, look at the tables on pages 6 and 7 of Vanguard's report.
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