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The tremors in tech stocks are making some people uneasy. The alarming low level of consumer confidence in the U.S., as reported last week by the University of Michigan, are adding to concerns.
The situation prompted a question from a reader, who wrote: “I would like some suggestions as to where one should park cash to avoid a possible upcoming market meltdown. I have been operating my and my wife’s investment portfolios for the last ten years or so. The combined value is just under $2-million. About 25 per cent of our investments are in Mawer Balanced Funds (30 per cent bonds). Until recently, the rest has been mostly in ETFs, but I have been steadily selling and accumulating cash.
“I would like to know what options there are for parking the cash. Should I be buying more balanced funds? Should I be thinking about an annuity?” – Bert B.
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It’s a good question. There are many places to park cash, but none is perfect. Balanced funds don’t fit. They are typically divided between stocks and bonds, both of which are subject to market fluctuations. The Mawer funds our reader owns are conservatively managed, but don’t fit into the “cash” category.
Here is a rundown of the cash options, with the pros and cons of each.
Savings accounts
The easiest way to accumulate cash is through a savings account with your bank.
Pros: Your money is liquid, so you can access it at any time. It’s not a tradeable asset, so market movements are not a concern. The account is covered by deposit insurance up to the $100,000 limit.
Cons: The deposit insurance coverage is too low and badly outdated. For a couple with a $2 million portfolio, the current limit would cover only 10 per cent of the total ($100,000 each). For full coverage, the money would have to be spread over 10 institutions!
Another negative is the low rate offered on savings accounts. At the major banks, it will usually be much less than 1 per cent. Right now, Royal Bank is paying 0.55 per cent on its High Interest eSavings account. That’s well below the rate of inflation, which means the purchasing power of your money is eroding month by month.
GICs
Guaranteed Investment Certificates offer a set interest rate for the full period until maturity.
Pros: The major benefit is a much higher rate of return than you’ll earn from a savings account. GICs are also covered by deposit insurance.
Cons: Your money is tied up until maturity, so liquidity is a major issue. The low deposit insurance coverage is a concern here as well.
Cash ETFs
In recent years, we’ve seen the emergence of cash-based exchange-traded funds. These typically invest in savings accounts with the big six Canadian banks but receive a better interest rate than an individual because of their buying power.
Pros: A better return on your money. The CI High Interest Savings ETF CSAV-T is currently making monthly payments at an annualized rate of 2.6 per cent.
Cons: The return will decline as interest rates fall. No deposit insurance. Plus, these ETFs are tradeable assets that have not yet been tested in a market crash.
Money market funds
These are mutual funds or ETFs that invest in short-term securities, such as Treasury bills.
Pros: Very low risk. Most MMFs hold T-bills issued by the Canadian or U.S. governments. Any default would indicate a complete collapse of the financial system.
Cons: No deposit insurance. Low returns. The iShares Premium Money Market ETF CMR-T has averaged only 1.4 per cent a year since its inception in 2008.
Annuities
These are contracts purchased from an insurance company that provide regular monthly or quarterly payments. They offer steady income, usually for life.
Pros: Predictable cash flow ensures your money won’t run out.
Cons: Loss of control. The buyer is handing over his/her savings in exchange for income for life. Unless the policy guarantees a minimum fixed term, all payments cease at death. There is no residue for heirs.
The strength of the company is also a factor. Although it’s unlikely, it’s feasible an insurance company could fail in a financial crisis, leaving annuity holders exposed.
Under the mattress
I doubt anyone actually hides money under the mattress, but the term refers to keeping it close at hand in your home – probably in a safe.
Pros: You know where the money is, and you can access it any time.
Cons: No interest. In fact, inflation will erode the purchasing power of your cash every day. Another worry is that your home may be targeted by robbers if word gets out there is a large amount of money inside.
Given these choices, I suggest a GIC ladder would be the best bet. This would involve investing one-fifth of the money to mature every year on a rolling basis. So, in our reader’s case, $400,000 would go into a one-year GIC, $400,000 into a two-year certificate, and so on out to five years. This ensures some money will be available each year to be spent or reinvested at the current five-year rate.
It’s not the perfect solution, but it’s the best I can suggest in the circumstances.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.