But Cash Is Earning Zero

The idea of cash earning zero comes up every so often in interviews, in the context of managers needing to put cash to work because of the low yield, or "you don't get paid to sit in cash" or managers needing to get invested ahead of the quarter (window dressing).

This is entirely the wrong context. If you knew that stocks would double over the next year, then a money market yield of zero is bad. If you knew that stocks would be cut in half over the next year, then a money market yield of zero is fantastic.

Obviously no one knows whether stocks will go up 100% (unlikely), down 50% (unlikely) or something in between (likely). People who actively manage portfolios (for themselves or others) probably have an opinion about direction and tilt to that opinion in some magnitude. In this context, cash becomes a tactical tool regardless of the yield. As a tool, it is used in correct proportion for a given period or it isn't, but the idea of "too much cash" is not complete without context.

During the worst of the recent (current?) bear market I met with my firm's primary point of contact at Schwab and he mentioned something about our cash level being high - this, as the market was puking down. To put it in Hussmanesque terms, if risks favor the downside, then having cash - regardless of the yield - becomes the correct tactical decision.

Unfortunately, much of what we see in the media asks the wrong questions or more correctly frames the context incorrectly. "I see you don't like financials" is one example. Actively (so not passive) navigating market cycles can be made much easier (not easy, easier) by weighing risks and rewards of various things you invest in, either broad asset classes, investing at the sector level, country level or however narrow you go.

In too many interviews in the media, maybe as a function of time, the questions asked do not necessarily seek the correct context and the person being interviewed may or may not realize this and add in that context. Anytime you read or hear anyone speak, it is important to realize there could be more context as not every one tells you everything he is thinking, like Jimmy Rogers.

Comments

[Zack Miller:]

amen!

Sep 16 10:00 AM

[LT Trader:]

I'm truly amazed that this is an editor's pick. When it comes to "cash", there are lots of reasons to hold. Cash should be held for short-term goals such as upcoming downpayment on home or car and other big ticket purchase items. If riskier assets are held, those goals may have to be deferred.

There are lots of reasons to have "liquidity." I believe the blinders were put on when this article focuses only on tactical investment decisions in the equity arena.

Sep 16 10:09 AM

[Robert Mart...:]

Roger:

Your observation bears repetition: Cash is an asset class, and a decision to hold cash is an active decision.

Unfortunately, cash is consistently neglected as an asset class because almost no one in the media or the wealth management industry gets paid to recommend cash. (I discussed this peripherally in my musings about ETFs and the wealth management industry, here: seekingalpha.com/artic...

Nevertheless, some of the smartest folks at many hedge funds hold LOTS of cash, and their clients are quite happy, even after fees are considered. Their clients understand comprehensive asset management MUST consider cash as a tactical/strategic asset that a PM actively manages.

Thanks,
Rob

Sep 16 12:22 PM

[SmartMoneyJoe:]

It is a well-known fact that every investment can be risky, but some investments have a greater risk than others. Risk tolerance is the amount of money you feel comfortable investing with the risk factor in mind. If you are basically a conservation person, then you will probably be most comfortable taking limited risks by investing in cash, secure stock and fixed income investments. If you consideration taking moderate risks, than you could consider putting your assets into growth stocks, and if you are willing to take significant risks, then high-risk investments are for you.

There are different types of investments to choose from. Stocks are equity investments that give you a share in a corporation. Bonds or fixed income securities pay interest over a fixed period of time. To understand mutual funds you need to know that they are diverse equity funds that pool money together from many different investors for greater buying power. Futures are obligations to buy or sell a specific commodity at a preset price on a specific day. Options give you rights to buy or sell a specific stock, bond, etc at a preset price during a specified time period.

The term asset allocation simply means how you divide your investments between stocks, bonds, mutual funds and cash equivalents. This depends on your financial goals, when you want to achieve them, and your willingness to risk. Next in line comes diversification that allows for further spreading your investments between the major asset categories of stocks, bonds and cash equivalents. Diversification helps you decrease your investment risk. As you know, no investment is risk free. Without risk, there would be no reward.
----------------------...
Look after your pennies, and your pounds will look after themselves.
www.personalbudgetinve...

Sep 16 01:35 PM

[jack dee:]

Thank you for the timely reminder. It is easy to forget the value of cash as an asset class.

Sep 16 02:33 PM

[Emerald:]

Short term Treasuries (SHY) and short term investment grade bonds, although slightly more risky, work as cash substitutes for me and yield between 1.5% and 2.5%.

Sep 16 03:25 PM

[Albert Ling:]

Cash today has negative yield, because government inflation numbers are tweaked to the downside.

So TIPS are useless also, cause they track the CPI indicator.

On normal times, cash is a lousy asset class, on times of distress and uncertainty such as now, contrary to popular opinion, asset is a horrible asset class. Look at what happened in the Weimar Republic

Sep 16 11:56 PM

[carey_jim:]

Holding cash is, basically, keeping your eye on the 800 pound gorilla in the room that everyone is trying to ignore: deflation.

And as Robert Mart .... points out: "no one in the wealth management industry gets paid to recommend cash" so, surprise, surprise, it has few advocates.

And I might add, nobody gets paid to predict deflation either, and virtually no one living today remembers the deflation of the 1930's.

In the unlikely event that America experiences hyperinflation, there will be time to buy more real property and/or switch one's cash holdings into foreign currencies. That unlikely time has not arrived and we have no historical precedent in the United States except for short periods after our own wars and revolutions which produced only mild inflation of relatively short duration.

Sep 17 05:37 AM

[kmf:]

Jim Carey above got it right. Right now we are still experiencing deflation. The gvt. has poured lots of $$ in every corner to avoid a runaway deflation but stopping deflation, probably between 1% and 2% is presently the case. The gvt. will not raise short term interest rates for a long time because the experience has been that if you do raise prematurely then bad things happen and Bernacke knows this. So if you are holding cash although the interest rate is near zero the buying power of the savings are going up. Somewhere along the line prices will rise but not when the unemployment rate is rising towards 10%.

Sep 17 08:58 AM

[captmanning:]

Most of the commenters seem to be in "the wealth management industry" and treat cash as a big pile of Other People's Money and try to get some of it. Mr. Nussbaum reminds small private investors like me to check our bank balances as well as our brokerage account balance. As Yogi Berra says "Cash is just as good as money." Just because you sharks are circling and need to make your commissions is not reason enough to throw money at the flavor of the month abbreviation. Your comments here make Mr. Nussbaum's point.

Sep 17 09:48 AM

[axelrod608:]

Timely article and generally great comments. I get a chuckle out of the SA poster that says evry day "this market just keeps going higher, no force on earth can stop it". Last time I checked, EVERY market over time goes up AND down.

Yes, we've had a great run. And it won't continue forever. I see signs of topping out and am over 95% in cash. I can more afford to pass up the last 5 or 10% of gains than I can afford to lose 5 or 10% of capital. I've locked in 20% gains for the year. Last year I was 50% up at mid year and ended up less than 1%. Live and learn.

After last year, my risk tolerance level changed greatly. I'm retired and can't afford to lose capital.

Sep 17 10:02 AM

[Buckoux:]

Rather obvious , isn't it. Some of them drool over "opm".


On Sep 17 09:48 AM captmanning wrote:

> Most of the commenter's seem to be in "the wealth management >industry" and treat cash as a big pile of Other People's Money and try to >get some of it.

Sep 17 11:41 AM

[BerkeleyBob:]

Good, thought-provoking post and some interesting responses. I remain diversified and fairly fully invested in equities, ETF's, MLP's, one REIT and mutuals, but have 30% of my IRA rollover in cash or equivalent. One of the things I like about my broker (Schwab) is that I have never sensed any sales pitch or unseemly desire for generating a commission...

Sep 17 12:12 PM

[jackooo:]

You sit in cash and you die. Many good stocks, preferred, pay a 5% plus yield. Why sit in cash?
You need at least 6% to beat inflation after taxes. Your 1% or so in cash is than taxed and you lose, lose, lose.
I rather invest and take the chance rather than lose in cash for sure.

Sep 17 02:03 PM

[jse17:]

"Anytime you read or hear anyone speak, it is important to realize there could be more context as not every one tells you everything he is thinking, like Jimmy Rogers."

I will assume Roger implies that "Ole" Jimmy is not the benevolent, altruistic, compassionate, selfless soul, and every investor’s best friend portrayed in his never ending television appearances.

Ask yourself, would you buy a used car from this guy?

Sep 21 07:27 PM

[JeffDB:]

On Sep 17 05:37 AM carey_jim wrote:

> And I might add, nobody gets paid to predict deflation either, and virtually no one living today remembers the deflation of the 1930's. >

Although there may be some risk of deflation, and cash would be a good asset class in such a scenario, I think it should be pointed out that we were still on a gold standard in the 1930s even if personal ownership was outlawed. The fiat money came later, and I think the risk of significant deflation has dropped significantly since the 1930s. The government plays a far bigger role in the economy now. They won't be laying off much, if any of the vast bureaucracy, but if anything are ramping up for things such as the "cash for clunkers", and various "czars" and their fiefdoms overseeing their new acquisitions in the auto industry etc. There are also automatic fiscal stimuli are built into the system which were not there in the 1930s, such as unemployment benefits, food stamps, welfare, medicaid etc. Then too, we have "Helicopter Ben" at the controls of our fiat money supply, and he has specialized in the study of the Great Depression and has vowed to do whatever it takes to prevent a recurrence.

I think hyper inflation is a much greater risk and I don't think anyone should count on being able to quickly adjust to a shift to hyper inflation anymore than they should wait until the last minute to evacuate for an impending hurricane:

seekingalpha.com/insta...

But, for the record, I think there is a valid place for cash in one's portfolio, for reasons the author and others here have mentioned. But I do think the lower yield - ie. near zero - should have a tendency to push people to find alternatives. If alternatives are overvalued or otherwise too risky, certainly a higher percentage should go into cash, but all things being equal, a lower return for cash should reduce the percentage of cash in one's portfolio. Double digit money market returns should pull money out of alternatives (assuming a lower expected inflation rate than double digits) and near zero returns should typically push money out of them.


In the unlikely event that America experiences hyperinflation, there will be time to buy more real property and/or switch one's cash holdings into foreign currencies. That unlikely time has not arrived and we have no historical precedent in the United States except for short periods after our own wars and revolutions which produced only mild inflation of relatively short duration.

Oct 05 12:26 PM