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Summary

  • Despite the logical notion that equities tend to be quite profitable over the long-term, many hold cash* and wait for an opportunity.
  • *Not only cash, but cash that is above and beyond what one might consider reasonable for an emergency fund.
  • Waiting for an opportunity sounds great in theory, but is much harder to accomplish in practice.
  • As such, there are many high-yielding alternatives that appear to be a perfectly reasonable alternate to unproductive cash today.

With today's environment, I don't need to tell you that interest rates are low (although I suppose I just did). But to quantify things, how low are they? Well, if you search for "average savings account rate" you might come across things like this: Bankrate.com says the national average for a money market account stands at just 0.10% and another source suggests that it's 0.17%. Whatever way you slice it, it's clear that cash balances "earn" effectively nothing (sometimes literally). It's truly historic times.

Yet a recent study found that investors held an average of 40% of their assets in cash. Moreover, for those with assets of less than $250,000, the number was 50% of their wealth in cash.

My question is this: how do you hold so much cash when companies like Realty Income (NYSE:O) and AT&T (NYSE:T) exist?

Now obviously there are many reasons to have liquidity. Chief among them include having an emergency fund, saving up for a specific purchase or just sleeping well at night. There's no greater satisfaction than knowing you are financially sound in the event of a monetary crisis. This article is not addressing this necessary and indispensable reserve fund. It's always prudent to have the liquidity on hand that you need or may need.

This article is strictly talking about the cash that goes above and beyond your everyday emergency fund. The cash that can be invested but instead is earning nothing or next to nothing. That is, an unproductive asset that has the ability to be productive.

My solution is simple: take the cash that is losing purchasing power and transform it into a partnership with a high-yield company or group of companies. In reality, any collection of equity partnerships would likely work just fine over the long term, but for this article we'll focus on the higher yields. Specifically, you could look at something like Realty Income (O) or AT&T (T).

Take Realty Income as a beginning example. For illustrative purposes, let's imagine you have an investable $10,000 that's sitting around in a savings account. If you were like the national average, this would equate to $10 in yearly interest. Even if you're above average, you might be talking $40 or $50. On the other hand, Realty Income has two interesting components: it's known as the "monthly dividend company," and it presently yields about 5%. Stated differently, what your cash makes in a year a Realty Income partnership would send to you in a month. Granted, this income flow isn't guaranteed, but Realty Income does have a pretty good track record: having paid a dividend each month for 45 years. Plus, it's not as though there's a tax advantage with the savings account -- in both instances you would be paying regular taxes.

If we move on to a security like AT&T, with its 5.3% "current" yield, the possibilities improve a bit. It is true that these dividend payments are quarterly, but you have the tax advantage of qualified dividends. In this case, you have a 1.3% yield being paid every 90 days. What you receive in a quarter from AT&T could take you years to achieve with a regular savings account. Moreover, AT&T has not only paid but also increased its dividend for 30 consecutive years.

In both instances, you have the claim on an underlying partnership with a solid stream of income that has proved reliable. Granted anything can happen in the future, but both securities appear to be reasonable places to begin looking for cash alternatives.

With that being said, it should be underscored that I'm not "picking" any particular security. I could have done the same type of breakdown with Southern Company (NYSE:SO), McDonald's (NYSE:MCD) or Target (NYSE:TGT), as examples. I'm simply suggesting that cash loses purchasing power over time while equity partnerships tend to preserve it. It just so happens that many of these companies also offer more income today as well.

Now you can quibble over paying "too much" for this or that. If the argument is whether you should buy say AT&T, McDonald's or Wal-Mart (NYSE:WMT), then I would understand -- which one provides the best value proposition depends on estimates of the company's future prospects and related payouts. Yet if your option is between holding investable cash and owning AT&T, the line of reasoning appears deficient. We all know that cash is a depreciating asset.

Of course, a common argument for keeping "dry powder" is that you want to wait for opportunities -- which sounds great in practice. However, the problem comes in the way of following through with it. It has been demonstrated numerous times that individual investors aren't particularly good at timing the market. Moreover, in the aggregate everyone has to be average less fees. More plainly, "waiting for an opportunity" is akin to betting against the house.

A corollary to this notion is the idea that there are three basic outcomes in the market. The possibilities include: higher prices/valuations, lower prices/valuations or roughly similar valuations (which consequently mean higher prices) in the future. Thus in 2 of the 3 scenarios, you want to be invested rather than holding cash. You might believe you can predict when there will be lower valuations, but as described, this is easier said than done. Someone could have said that they were waiting for opportunities in the beginning of 2012 or 2013 and today they would still be waiting. Perhaps an "opportune time" will come in the future, but it seems that the risks of being out of the "game" are far greater than the risks of being in it.

As a final remark, if you have an aggregate basket of equity holdings, you could effectively ignore the stock price (bids) for the next decade or two and instead focus on the income streams. In doing so, you'd wake up 20 years later with a solid probability of both higher prices and higher income in the future. People tend to get in trouble when they buy AT&T at $35 and then start thinking about whether or not it was a good decision when it opens the next day at $34. As long as the income keeps rolling in -- and you have no intention of selling immediately -- you simply don't need to pay attention to the everyday liquidity bids.

Here's the takeaway: cash is useful in the sense of an emergency fund. However, any amount beyond what is required is losing purchasing power over time. As such, it might be prudent to search for high-yield alternatives to replace the investable yet unproductive cash.

Disclosure: The author is long T, MCD, WMT, SO, TGT. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: How Do You Hold Cash When Realty Income Or AT&T Are Available?