It is very likely that you own a zombie investment. The money market fund – one of the most important tools for savers over the past several decades – is now essentially among the walking dead. It has a form but no substance and almost no value.
Article from THE NEWS TRIBUNE
Published: 01/06/12 12:05 am
It is very likely that you own a zombie investment. The money market fund – one of the most important tools for savers over the past several decades – is now essentially among the walking dead. It has a form but no substance and almost no value.
It is unfortunate that an investment that held $2.7 trillion to end 2011 has eroded from important vehicle for cash management to nearly useless for savings.
According to Bankrate.com, the average 30-day compounded yield on money market mutual funds at the end of December was 0.02 percent. Two hundredths of one percent. That’s very little incentive to use something other than an old coffee can to store your savings.
Given short-term interest rates kept on the floor by the Federal Reserve and regulatory changes that have limited the types of investments money market funds can own, there is essentially no return available. Even under better economic conditions, money market funds are not likely to return to the days of paying attractive interest.
What to do with your cash has become a significant money management problem. Whether it’s in a money market mutual fund, a “high-yield” online bank savings account, CDs or Treasury bills, savers are being punished with a negative real return. All of these cash management vehicles have for quite awhile now, paid out interest at a rate much lower than inflation. Building up savings to better manage your financial situation is actually costing you money because of the diminished purchasing power of those dollars. Low interest rates allow the government to borrow money at a tremendous value, compared to historical rates, but they essentially create a hidden tax on savers.
BUILDING BLOCKS OF FINANCIAL SECURITY
Cash-equivalent investments are at the foundation of any well- designed financial plan. They have served many purposes without being complex. They may be the boring part of a financial plan but are generally safe and meant to provide some reward for building cash reserves or saving for a goal.
To generate much income at all, let alone keep up with inflation, many savers are being forced to climb the first step on the risk ladder to invest in short-term bonds and other vehicles that have less certainty of protecting principle over any given period. This isn’t much of a problem for some investors but it does introduce the need to scrutinize what risks are being taken and what the probability of permanent loss is. This is something new for people used to FDIC guarantees on their cash-equivalent investments.
It becomes important to understand credit risk, duration of the holdings and particularly interest rate risk. Once the Fed does increase interest rates, possibly not before the middle of 2013, many types of bonds will be negatively affected. This is part of the reason why trillions of dollars remains in money market funds. People don’t want to take risk with their cash. And if they do take some risk, they would prefer to have a more meaningful reward than the also microscopic returns available from short-term bonds.
YOUR ZOMBIE INVESTMENT DEFENSE KIT
First, determine your requirement for cash. How much liquid money do you need over the next 24 months? Keep in mind that even someone with a well-managed budget and a steady job should keep at least three months worth of expenses in cash. And if you have a big-ticket expense in the near future, the money allocated for it shouldn’t be exposed to market risks. The best current option for your required cash is an online savings account. They are easy to set up and link to your checking account for movement back and forth. They are available with no fees, no minimum dollar amount or holding period and they are FDIC-insured. ING Direct, Capital One, HSBC and others currently pay .75 percent or better annual percentage yield. It may still trail inflation but is many times better than money market fund offerings. In a CD, you would have to lock up your money for more than 18 months to get an equivalent rate.
Once you’ve got enough set aside for your emergency fund, there may not be much reason to keep an allocation to cash in your investment portfolio. Especially if your investment mix is liquid and well diversified, you may find it just fine to stay more fully invested, perhaps overweighting your typical allotment to short-term high-quality bonds.
Unfortunately, however, the days of the risk-free three percent return on your cash are long gone and may not return for a long time.
Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Old Town Tacoma. Reach him at gary@bhjadvisors.com.
Article from THE NEWS TRIBUNE