Aug 27, 201408:18 AMFinancial Perspectives
with Michael Dubis, CFP
Can cash really be an ‘investment’?
(page 1 of 2)
Cash or cash equivalents like money markets or savings accounts are occasionally considered money “not doing anything” for you. And I don’t blame folks for thinking this way, given that yields on cash are essentially 0% to maybe 0.75% (judging by a cursory review of FDIC options via various online banks).
I recently reviewed an analysis report noting that, in April, $4.13 was invested in stocks for every $1 in money markets. Assuming this resource is accurate, this represents one of the highest stock-to-cash ratios in the last 30 years. Clearly, people are getting tired of “earning nothing.”
I think this type of thinking could be a mistake, though. Cash can be viewed as both a “savings” vehicle for short-term goals and an “investment vehicle” as part of a diversified long-term portfolio. Just because cash doesn’t have any (or very little) earnings associated with it right now doesn’t mean it’s “not doing anything” for you.
For the sake of discussion, let’s focus on cash as a long-term component of an investment plan (i.e., a piece of your asset allocation plan consistent with your own goals, objectives, risk tolerance, etc.). Furthermore, I’m in no way making any market-timing calls here or trying to argue to alter any well-designed plans you may have. I’m simply looking to shed some light on what, these days, is a rather unloved asset and then let you decide.
For starters, cash (assuming it’s FDIC-insured) always does two critical things in a long-term portfolio, no matter what environment we’re in:
1. It is one of the only asset classes that can handle a shock to the markets, such as occurred during the crisis of 2007-09. Crises are rare, but when they happen, they are shocking, and so shock-absorbent asset classes, even in small doses, can add value to a long-term portfolio by cushioning equity and credit downsides. However, because crises are rare, having too much in a shock-absorbent asset may be inappropriate for a long-term investment portfolio. Balance seems sensible here.
2. More commonly, cash allows you to efficiently redeploy capital, whether that means dollar-cost-averaging your cash into stocks, bonds, etc., during your accumulation years or using it for distribution needs in retirement (usually through dividends, interest, principal, and/or capital gains distributions). Without having some cash around, it’s possible the tax impact of reinvesting or distributing funds could be unnecessarily negative.
3. Another attribute of cash today — given that yields are low not just for cash but essentially all bond instruments — is that cash can actually offer a compelling cushion in your portfolios as a hedge against possible interest-rate risks. In a very low-yielding interest-rate environment, increases in interest rates have a much larger impact on bonds than in a higher-yielding environment (all else being equal).
A good example of this would be comparing money-market cash — assuming a yield of 0.50% (you can actually find a higher yield than this at various online-bank money markets) — to that of a short-term bond index fund.