May 14, 2012: Cash Is The King

05/15/2012 Share 0 comments

Re-balance Cycle Reminder

Based on our monthly re-balance calendar, the next re-balance time will be on Monday, May 28, 2012. You can also find the re-balance calendar of 2012 on 'My Portfolios' page.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Also please note that we now list the next re-balance date on every portfolio page.

Cash Is The King

We continue our coverage on the four corner concept for building an all weather portfolio. See our pervious newsletters April 23, 2012: All Weather Portfolio Construction, April 30, 2012: Inflation Hedges, and May 7, 2012: Bonds As Deflation Hedges if you missed them.

In this article, we will discuss the cash corner.

Cash is perhaps one of the least exciting but equally important (if not more important) asset classes that serve as the foundation for our everyday's life as well as long or short term investment portfolios.

When we talk about cash, what is usually implied are the short term investments that are considered safe. For short term investments, the following is the spectrum in the order of safest to riskiest:

• 90 days Treasury Bill. The U.S. Treasury bills are still considered to be the safest securities. They are backed full faith by the U.S. government.
• Bank deposits (savings accounts) and Certificates of Deposits (CDs) that are FDIC insured. Note in an investment brokerage account, cash accounts with up to $100K are insured by FDICs
• savings, CDs and cash in a brokerage account that are not insured by FDICs but have third party insurances and/or guarantees.
• Money market funds in a brokerage account that are not insured by FDICs.
• (ultra) short term treasury bills or investment grade corporate bonds with fixed maturities.
• ultra short term treasury bills or investment grade corporate bond funds.

The following illustrates types of cash and the relationships among banks, brokerages and mutual fund companies.

Carefully choosing types of cash and banks or brokerages to park your cash can result in substantial savings or gains. Many banks offer various CDs rates, for example, that can differ substantially. For example, based on bankrate.com, the highest one year CD rates are offered by Doral bank (APY 1.15%) and CIT Bank (APY 1.11%) with $1,000 minimum. On the other hand, the lowest rate is 0.25%. The 0.9% difference for a $10,000 CD is $90 while for a $100,000 CD is $900 (you can buy 2 or 3 iPads!).

With today's electronic money transfer becoming more and more secure and easy to use, it is very easy to use ACH (most of banks and brokerages offer it for free, if your banks or brokerages do not, it is time to look for a new one).

It used to be that different brokerages offered very different cash or money market fund interest rates (or yields). Though in today's extremely zero interest rate environment, this becomes almost non-issue: last check, both Schwab and TDAmeritrade offer their cash sweep money market fund yields at 0.01% and there isn't much a bank or brokerage can do to enhance this (though Schwab offers higher yields (such as 0.06%) for $500,000 and up asset accounts). However, once rates climb back, you shouldn't forget this difference.

CD or Bond Ladders

For any money that you plan for more than 1 year, we believe investors and/or savers should consider so called CD or bond ladders. The idea is to choose CDs or bonds with various maturities so that you can avoid interest rate risk (in a rising rate environment, the shorter maturity, the better while it is the opposite in a falling rate environment). A typical ladder for $30,000 money planned for 3 years can look like:

$10,000 1-year CD

$10,000 2-year CD

$10,000 3-year CD

and when a CD matures, you can reinvest to the another 3 year CD if you don't plan to spend that money.

Same for bond laddering. However, for bond investing, two obstacles exist: 1. it requires considerable efforts to do research on individual bonds; 2. it requires large amount of money for each purchase. For example, many individual bonds require $100,000 minimum.

Fortunately, a recent important bond ETF offering eliminates the above drawbacks. The following Guggenheim Bulletshares fixed maturity bond funds offer both diversification and affordability:

The high yield bond ETFs:

For example, let's take a look at Guggenheim BulletShares 2012 High Yield Corporate Bond ETF (BSJC):

• Number of holdings: 47 
• 30-Day SEC Yield: 5.13 %
• Weighted Average Yield to Maturity: 4.70 %
• Weighted Average Yield to Worst: 2.03 %
• Expense: 0.42%
• Bid/Ask Premium (Discount): -0.16%
• Volume: 40,544

The main drawbacks are a bit high expense ratio (it would be nice to reduce it to their corporate bond ETF's expense ratio 0.24%), relatively low volume (but still reasonable for a patient investor).

For the above fund, basically, one can expect to have annual yield from 2.03% (the worst) to 4.7% by December 31, 2012. This is 1 to 3% percentages higher than CD rates!

We view the fixed maturity bond funds are significant products to enhance cash and short term investments substantially. As time goes, we will publish more on this.

To summarize, people tend to spend numerous time to bargain hunt cheaper stuff but instead shun away devoting just some nominal time to get better returns on their investments. Contrary to popular belief, cash and short term investments are much sexier than what you might think!

Portfolio Reviews

Funds from a lazy portfolio proposed by Guru investors can be used to form a good investment plan as those funds have been carefully calibrated for diversification and cost purposes. Most of these lazy portfolios use low cost index funds. The following compares the performance of lazy portfolio tactical model portfolios listed on Lazy Portfolios page:

See lazy portfolio tactical model portfolio performance comparison for more details.

Overall, we are comfortable with our tactical asset strategy's performance. With more than 3 year live performance, we believe that it will deliver good performance with much lower risk in the future that is full of uncertainty.

Market Overview

Europe continues to present challenges to the global economy. However, we have made it clear also that this is not just an European problem. Looking around, we see emerging markets, Japanese markets and U.S. markets are all still under structural deficiencies that have not been corrected. JP Morgan Chase's recent $2 billion trading loss is yet another example to show such structural problems are alive and dangerous to global economic health.

Our major asset class trend table continues to show a deteriorating picture in current investment environment. As of today, it is surprising that US REITs are still the only major risk asset ranked high and above (see for example, Morningstar: REITs Way Overvalued). Our tactical asset allocation portfolios have fully taken advantage of such a strength for more than a year now. The tide is turning but yet to show a uniform downtrend. Just like a surfer, trend watching and systematic risk management of portfolios will help us to navigate through this kind of periods.

We again urge users to review their portfolios' risk levels. We don't know where the markets are going but it is prudent to be risk conscious at the moment.

See MyPlanIQ 360 Degree Market View for more details.

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