The Thrill of Cash
Every summer, I navigate the world of high-yielding investments for Kiplinger's Personal Finance to research a feature story on the wisest sources to invest for superior yields. My latest recommendations appear in this August's edition, soon to be available on the newsstand.
Last year, and for a couple of years prior, I ignored cash and cash equivalents. The yields were just way too small. But times have changed, as we know. Short-term interest rates are hugging 5% and haven't yet peaked. By comparison, real estate values and oil and gas prices appear to be taking a breather, although at high levels. Cash investments -- which I define as anything that pays interest, is immediately liquid and does not fluctuate in principal value -- aren't just safe. They're looking respectable as an investment, not just a refuge.
In financial parlance, you should get a generous "risk premium," or extra return, for investing in something like a high-yield bond fund or a real-estate investment trust instead of a riskless investment, namely, cash. As you can see, this premium is vanishing.
This week, Citibank is advertising an online savings account at 5% and Vanguard's prime money-market fund, which counts as a cash investment, yields 4.9%. By contrast, Vanguard's high-yield bond fund, which invests in low-rated corporate debt known as junk, yields 7.5%. This means you're collecting a puny 2.6% extra for choosing considerable risk over no risk at all.
Several years ago, this difference was around 8%, wide enough that junk bonds were a screaming buy. Not today. Also, most property-owning real-estate investment trusts yield less than 5% now, which is sometimes less than a high-paying bank deposit. Indeed, until the Federal Reserve Board not only stops raising short-term rates but actually cuts them, expect the gap between cash and longer-term or riskier bonds and income alternatives to stay narrow. And that favors cash.
So repeat after me: Cash is valuable. It's so valuable that it belongs in your investment portfolio, not just in your wallet and daily budget. And I'm not saying this only because of the interest-rate situation. There's another factor: competition.
You've seen the banking industry embrace e-commerce. Online pre-set bill paying, instant loan and mortgage quotes, and money transfers by PC are all useful. But the hottest thing in banking, if you ask me, is the new-age savings account. Giant institutions such as Citibank, Countrywide and HSBC are all entering the online savings business that ING Direct, itself no slouch, invented in 2000. So are many smaller and regional banks. You'll find the list at www.bankrate.com.
To watch this competition among the nation's giant lenders for ordinary savings tells me the business is awfully profitable, or will be. It stands to become a never-ending source of cash for the big banks to use as feedstock for high-margin lending businesses like credit cards. Online savings accounts usually have no account minimums or time requirements, as with certificates of deposit. (You may have to open a checking account or something). Online savings also are efficient, with no branches housing people to pay and lobbies to maintain. So I suspect, and plenty of financial advisers agree, that one online bank or another will always bid high enough to capture savings from rivals and from money-market funds and Treasury bills. The banks, after all, price their own accounts based on their knowledge of the marketplace, while money-market funds and T-bill buyers take what the marketplace offers. Money-market funds also often spend about 0.50% of assets on expenses.
A good online bank account now is at around 4.7%. ING Direct's Orange Savings, ironically, once the pacesetter, is in the back of the rate pack as I write this, paying 4.25%. Watch ING try to catch up.
I can't say what proportion of your income portfolio belongs in cash. If you're an 80% stock, 20% fixed-income retirement investor, I wouldn't be opposed for now to putting the entire 20% in cash rather than bond funds or CDs. The exceptions are if you need spending income and you own bonds that send you ample checks. Keep them; there's no reason to sell a bond and absorb a loss of principal because you'll eventually get the full principal back when the bond matures or is redeemed. I also would say to hold a REIT if you've owned it a long time and the trust generally raises its dividend rate.
I don't want to imply that online savings is flawless. Yes, the online bank accounts are set up so you can make easy transfers to a regular bank's checking account. Some also have ATM access. But they come up short on some investment conveniences. For example, you can have an IRA with ING Direct, but if you want something other than ING Orange Savings in the retirement account, you're limited to ING's nine in-house mutual funds. (That's what the ING representative told me). Citibank pays 5% on its e-savings account, but apparently you can't get that rate inside a Citi IRA, according to Citi's own crew. It must have something to do with the difference between banking and securities. A three-month Citibank CD pays 3.7%.
Obviously, you can just move the money around and eventually send checks to a regular brokerage account. And if you have an IRA with, say, Fidelity, you can get about as much with a three-month CD as with the best of these savings accounts. My serious point here is that as you balance your income investments between risky and riskless, the riskless (cash) stuff is getting better while the flip-side is showing a few scratches.