Consider These Cautious Alternatives to Just Squirreling Cash

Slightly more aggressive investments like REITs may be the answer for gun-shy investors.
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When the market gets rough, stash your cash -- or so many people figure.

Indeed, judging by how much bank savings accounts have grown this year, an increasing number of investors are hoarding their money. Bank savings-account balances grew by $264 billion from the beginning of January to the end of August this year, more than three times the $74 billion growth during the same time period in 2000, according to the Federal Reserve. Meanwhile, in the first eight months of this year, net flows into equity mutual funds have totaled a paltry $37 billion, almost one-sixth of the $204 billion during the same period last year, according to Lipper, a supplier of mutual fund information, analytical tools and commentary.

This isn't surprising, given that the average equity fund has lost 14% year to date, according to Lipper. But investors may be playing it too safe, say some financial planners. Bankrate.com, an Internet consumer finance marketplace, logs the average bank-savings account interest at a mere 1.58%. To be sure, market-shy investors might want to park their money in slightly more aggressive investments.

"Some of my clients are like deer in headlights," says Michael Ryan, a financial planner in Westerly, R.I. "They're sitting on cash or bank savings accounts when they should consider alternatives. The options are pretty dull but, still, they beat cash."

Take, for example, bank savings accounts, money market accounts and one-year certificates of deposit, which currently pay 1.58%, 1.71% and 3.42%, respectively. Such yields may not be much, but they appeal to the most risk-averse, since banks must insure up to $100,000 of your money with the Federal Deposit Insurance Corp., says Gerald Townsend, a financial planner in Raleigh, N.C.

Preferred Stock, Convertible Preferred Stock

Consider also preferred stock and convertible preferred stock. Preferred shares are a safer bet than common stock because they generally pay a fixed dividend to holders ahead of common stock owners. Also, should the company dissolve, either voluntarily or involuntarily, preferred shareholders must receive their issue's par value and accrued cash dividends before anything can be distributed to common stockholders. Essentially, preferred shares are purchased for fairly safe income, rather than for any capital gains possibilities.

Some preferred stock is convertible. An investor can exchange such a stock for other securities, usually common stock of the same corporation. The shareholder has control over when, or if, he or she wants to convert. But once the exchange is made, the shareholder can't go back. With convertible preferred shares, an investor has the chance to play both games. If the common stock isn't climbing, an investor can hang on to the preferred stock and reap a steady yield. But if a rally does hit, preferred stock gives investors the chance to convert their holdings into higher-yielding common stock. But buying that option comes at a cost. Convertible preferred stock typically pays lower dividends than preferred stock.

Money Market Mutual Funds

Another alternative is money market mutual funds, which are up 2.51% since the beginning of the year. Unlike bank money market accounts, money market mutual funds are not insured, but they do invest in highly conservative instruments such as commercial paper and certificates of deposit.

Fixed-Income Funds

No doubt bonds are back in vogue. That's why some financial planners are recommending fixed-income funds, which have increased an average of 5.17% in value so far this year. Kathleen Kee, a financial planner in Portland, Ore., is also recommending Treasuries and such short-term bonds as muni preferreds. "Muni preferreds are tax-free, seven-day trusts that typically deliver slightly better returns than money markets, and all of these bonds are insured and are triple-A rated," she says.

Loan Participation Funds

Likewise, investors should consider loan participation funds, also known as prime rate funds. These funds buy portions of corporate loans issued by banks and pass along the interest to investors. Such funds returned 1.77% from the beginning of January to the end of August, just slightly ahead of money market funds. "These funds typically return 50 to 70 basis points more than money market funds since these are securitized loans," says Townsend.

Real Estate Investment Trusts

REITs, be they equity REITs or mortgage REITs, also have been popular havens for investors this year. Equity REITs take equity positions in real estate and share the rental income with shareholders, whereas mortgage REITs lend money to developers and share the interest with shareholders. On average, REITs are up 10.33% so far this year.

"Real estate funds offer a more comfortable spot in the market because they are far less volatile than stocks and offer a steady stream of income," says Marilyn Capelli Dimitroff, a financial planner in Bloomfield Hills, Mich.

Diversify

This is not to say all financial planners are shunning stocks. In fact, a good number of them say now is the time to jump into the market because many issues are cheap. Put no more than 20% to 30% of your money into cash or cash-equivalent investments, these financial professionals say. "Conservative investing is dumb investing," says Harold Evensky, a financial planner in Coral Gables, Fla. "People confuse preservation of principal with safety, and that's not good. If they move too much money into these conservative investments, they'll miss the rally when it comes. The trick is to have a diversified portfolio."

But Richard Moran, a financial planner in Rolling Hills Estates, Calif., recommends a slightly more cautious strategy toward the market. Moran tells his clients to invest 50% of their money in intermediate-term bonds, 25% in a money market or similar type of conservative investment and only 25% in stocks. "Ultimately, as the market rebounds, we will phase these clients back into a 75% equity position, but for now we are playing it safe," he says.