Manage Cash Investments Smartly

Many investors have a common misunderstanding that one cannot do very much with cash. Thus, they don’t know or simply don’t want to deal with cash investments. However, cash or short-term investments are paramount to everyday life. Regardless of whether you are a retiree or a working person, you’ll have much need to stash a relatively large sum of cash for immediate usage in a 1- to 5-year time frame. In today’s uncertain stock markets, cash and short-term investments have an increasingly important role in your portfolio.

For example, for many Tactical Asset Allocation or Strategic Asset Allocation portfolios, you can find right now, a large percentage of the portfolio is in cash.  Though we mostly put this portion of cash to money market funds provided in your plan or brokerage accounts, the problem here is that these money market funds are practically producing sub zero interests. 

If you have a large portfolio, it might be a better idea to separate your investments into equity only, fixed income and cash. The equity only portion corresponds to a risk profile 0 portfolio in MyPlanIQ’s framework (meaning 0% is invested in fixed income in a normal market environment. However,  for a tactical portfolio, in an adverse market condition, the fixed income portion in this equity-only portfolio can go up to anywhere 100% to avoid big loss).  Your overall risk profile is really the ratio of the fixed income + cash over the equity only portfolio. 

Now, for the cash and fixed income portion, there are several ways to enhance your returns

High Yield Savings and CDs

You can find most info on current high yield or higher interest paying checkings, savings or CDs from bankrate.com. You can find the national average and range of interest rates of CDs, checking and savings as well as money market accounts. 

At the last check, the CD rates are: 

These rates are extremely low but if you are diligent, you can manage to find something close to 1%. For example, the GE Capital and Ally Bank are providing some very enticing rates for both CDs and Money Market Accounts at the moment. 

Bond Ladders

However, there are other ways to enhance your near term cash or fixed income investments. One way to do that is to utilize individual bonds that have fixed maturity. Investors should be aware that there is a major difference between an individual bond and a general bond fund. An individual bond has a fixed maturity such that the bond holder can get his/her full or partial principal back when the bond is mature. This means that as long as the bond is held to the maturity, you are not subject to any interim interest rate or credit rating fluctuation (which can affect the bond price dramatically) because the interim prices are irrelevant. What the bond holder cares most is whether he/she can get the full interest coupon payments and the full principal back at the maturity. 

However, a general bond fund such as PIMCO total return bond fund holds a basket of bonds that will mature in different time. Furthermore, to make sure a bond fund is an intermediate term bond fund, for example, the fund manager has to sell those bonds that are close to their maturity dates. This makes a bond fund is valued based on its collective value on any specific date and it will never mature. 

Investors who have large amount of capital often favor specific bonds to meet their cash flow and/or spending needs. They build their own bond portfolios. The most common technique to build a bond portfolio is to utilize so called bond ladder technique. A simple explanation is that instead of investing in several bonds that are mature at the same time, you can divide the money into several parts that have maturities in different time such as 1, 2, 3 years. The following is a good illustration: 

The problem of building your own individual bond portfolio is that, in addition to the laddering which helps to cope with interest rate risk, one would like to diversify holdings to various bonds (as least 5-10 bonds for each ladder) to minimize the individual bond default risks. To achieve this, it not only entails a sufficient number of bond holdings (ranging from 10 and up) but also requires fair amount of expertise and efforts to select individual bonds. 

The good news is that one can utilize defined maturity bond ETFs to solve the diversification problem. We have written an article on this Put Your Cash To Work: Defined Maturity Bond ETFs Can Help or (Compare CD Interests And Yields From Defined Maturity Bond ETFs). In addition to Guggenheim’s Bulletshares ETFs, iShares also has municipal bond and corporate bond fixed (or defined) maturity ETFs. 

Users at MyPlanIQ.com can use static portfolio feature to create and track a bond ladder portfolio. The following shows six bond ladder portfolios we are monitoring using Guggenheim BulletShares ETFs: 

**YTD: Year to Date

See detailed and up to date comparison >>

The ‘aggressive’ portfolios consist of BulletShares high yield bond ETFs while the ‘moderate’ portfolios consist of BulletShares corporate bond ETFs. A 3 Year Ladder has 1/3 in each of 3 ETFs that are mature in 2013, 2014 and 2015 respectively. The following shows the expenses and yield of Cash Or Short Term Bond Ladder 3 Years Aggressive: 

We feel that putting some portion of money to a high yield bond ETF that matures in 1 or 2 years has a favorable return vs. risk  ratio. For example, Fitch predicted in the early this year (2013) that the U.S. high yield bond default rate might be around 2-3%. Given 4.43% yield, a conservative 3% default rate and a recovery rate of  50% would still yield about 3%. 

However, we caution that investors should diversify, even among the corporate bond holdings to invest both investment grade and high yield bonds.  In fact, in 2009, corporate high yield bond default rate reached 13.5%, that would definitely affect your high yield bond ETF returns. 

Total Return Bond Funds Upgrade

As we mentioned in previous newsletters, we believe investing in a bond fund upgrade portfolio that rotates among some solid total return bond funds such as PIMCO total return bond fund or Doubleline total return bond fund is a solid way to manage your intermediate or even short term money.  

For more detailed discussion on these portfolios, see June 3, 2013: Total Return Bond Fund Portfolios For Major Brokerages. 

Portfolio Performance Review

We introduce our portfolio cloning technique long time ago. Information on SmartMoneyIQ Managers and Smart Money Indicators is extracted using our fund quantitative real time asset allocation analysis tool. The following table shows how the two cloning portfolios are compared against their target funds. 

Portfolio Performance Comparison

**YTD: Year to Date

See latest detailed comparison >> 

Each clone out performed its target fund. Though at the moment, in an environment where stock markets exhibit considerable strength, investors might tend to abandon these techniques, we remind our readers that a sound asset allocation technique is still sought after, especially when things are not as rosy as right now. 

Market Overview

The US government shutdown continues with the debt ceiling crisis hanging over. However, stocks continue to ascend. In fact, Russell 2000 just hit an all time high last Friday. It is also noticeable that emerging market stocks have recovered back, approaching the high on Sept. 18. However, we still maintain that the long term picture is not as bright as the short term one.  Staying the course is the best we can do. 

For more detailed asset class trends, see  360° Market Overview.

We again copy our position statements (from previous newsletters): 

Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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