How to Earn More on Your Cash
The combination of recent stock market volatility and falling bond yields has led many investors to increase the cash position in their portfolio, creating “dry powder” to use for future investment opportunities. Due to these higher-than-normal cash levels, maximizing the income earned on this cash has gained importance. This letter provides an overview of investment options for maximizing the return of this temporary cash and the pros and cons of each option.
An Argument Against Cash
Before we start, it must be said that over long periods of time, cash is a terrible asset class. Over full market cycles, it has historically underperformed stocks and bonds by wide margins and on average, there is a drag on performance from cash exposure in your portfolio. This is why we recommend investors generally minimize cash in their portfolios. While some may hold a minimal level of cash in their portfolio for ongoing cash flow needs (frictional cash), we advocate keeping cash as low as reasonably possible. For example, if stocks outperform cash by 5% per year and you keep 20% of your portfolio in cash, this causes a 1% drag on your performance. Said another way, instead of capturing the full 5% excess return of the stock market, your actual return is only 4% better.
However, with this being said, there are certain periods where a tactical position in cash can potentially add value and it pays to consider the ways to maximize the return on this temporary tactical cash and your ongoing frictional cash.
Options for Cash Holdings
There are many different ways to invest the cash in your portfolio. And while you can always just stuff $100 bills under your mattress, we don’t advise this approach for two reasons. One, it makes for an uncomfortable sleeping arrangement and two, it doesn’t earn any interest. If we are going to hold cash, we want to make sure we are maximizing the interest, or return, on our holdings.
The five most common methods for earning interest on your cash are to keep it in a savings account, invest it in a short-term certificate of deposit (CDs), buy a money market fund, leave it in your brokerage account, or purchase U.S. Treasury Bills. There are pros and cons to each of these options and the return of each option can vary greatly.
Overview: A savings account is a deposit account at a bank which generally earns a higher interest rate than a checking account.
Pros: Many investors already have a savings account; the cash is easy to access; balance is FDIC-insured (up to limits).
Cons: Interest rates are usually fairly low except for high-yield online savings account options; promotional rates are common so you may only benefit from an above-market rate temporarily.
Overview: A short-term certificate-of-deposit (CD) is a deposit at a bank for a fixed period of time. Because the period is set beforehand, generally banks will pay higher interest rates on CDs than their checking and savings accounts.
Pros: Balance is FDIC-insured (up to limits); ability to match maturity to the expected holding period.
Cons: Typically incur penalties for withdrawing money before maturity.
Money Market Fund
Overview: A money market fund is a mutual fund which invests in short-term cash and fixed income securities. It generally maintains a price of $1.00 and distributes income monthly.
Pros: Provides an attractive level of yield with daily liquidity.
Cons: While all money market funds attempt to maintain a $1 fund price, the $1 price is not guaranteed and it is possible to lose money in money market funds (which has happened in previous financial crises); most money market funds must be purchased rather than having your cash automatically swept into the fund; the funds have associated management fees.
Current yields: Yields vary greatly across funds (driven primarily by fees) and the level of risk taken in the fund (such as U.S. Treasury only, U.S. Government only, or Prime funds which can hold corporate debt).
U.S. Treasury Fund (SNSXX): 1.74%
U.S. Government Fund (SNVXX): 1.96%
Prime Fund (SWVXX): 2.01%
U.S. Treasury Fund (FZFXX): 1.79%
U.S. Government Fund (SPAXX): 1.77%
Prime Fund (SPRXX): 1.89%
Overview: A brokerage deposit is uninvested cash in your brokerage account. The majority of brokers pay interest on this cash held in your account but the interest earned can vary widely.
Pros: No action required so you can always earn interest on your cash.
Cons: Generally, interest rates are lower than money markets; some institutions pay no interest or a lower interest rate on smaller balances.
U.S. Treasury Bills
Overview: U.S. Treasury Bills (T-bills) are securities issued by the U.S. Treasury Department to fund the activities of the U.S. government. T-bills are issued for different maturities up to 1-year and do not pay interest but rather are sold at a discount to par. For example, a 1-year T-bill may cost $98 but matures at $100 (for a ~2% yield).
Pros: There is effectively zero default risk since T-bills have a U.S. government guarantee; T-bills generally have competitive interest rates compared to other cash instruments and provide the ability to match maturity to expected holding period but you can sell the T-bills early if necessary; earned interest is generally exempt from state and local taxes.
Cons: T-bills need to be purchased and trading incurs brokerage commissions; T-bills can typically be held in your existing brokerage account so no additional accounts are needed.
As you can see, investors have many options for their cash, however, your return varies greatly depending upon which option you choose. This is why weighing the pros/cons of each option and finding the option best suited to your cash needs can be very beneficial to maximize your returns.
For investors who typically keep large balances in their savings account at their local bank, an online savings account generally provides better returns.
For investors who typically keep large balances in their investment accounts, a money market fund or Treasury bills generally provide better returns.
At Ironstream, we actively work to eliminate cash drag in our clients’ portfolios, tying us not to short-term cash yields but capturing the long-term returns of stock and bond asset classes. However, for maximizing the return on tactical and frictional cash, we currently utilize a mix of Treasury bills and brokerage deposit. For our clients, we have found this approach generally provides the optimal mix between maximizing the return of cash yet preserving liquidity to quickly make opportunistic investments.
 FDIC: https://www.fdic.gov/regulations/resources/rates/, as of September 23, 2019
 Bankrate.com: https://www.bankrate.com/banking/savings/rates/, as of September 24, 2019
 Bankrate.com: https://www.bankrate.com/cd.aspx, as of September 24, 2019
 Charles Schwab: https://www.schwab.com/public/schwab/investing/accounts_products/investment/money_markets_funds/purchased_money_funds, as of September 23, 2019
 Fidelity: https://fundresearch.fidelity.com/mutual-funds/summary/316341304, as of August 31, 2019
 Fidelity: https://fundresearch.fidelity.com/mutual-funds/summary/31617H102, as of August 31, 2019
 Fidelity: https://fundresearch.fidelity.com/mutual-funds/summary/31617H201, as of August 31, 2019
 Fidelity: https://www.fidelity.com/mutual-funds/fidelity-funds/money-market-funds-fcash, as of September 19, 2019
 Schwab: https://www.schwab.com/public/schwab/investing/accounts_products/investment/cash_solutions, as of September 24, 2019
 Interactive Brokers: https://www.interactivebrokers.com/en/index.php?f=1595, as of September 24, 2019
 U.S. Department of the Treasury: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/TextView.aspx?data=yield, as of September 23, 2019
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