In the shadow of a surging economy, cash investments' stability holds a certain attraction


Monday, July 24th 2000, 12:00 am
By: News On 6


Greg Chesley has always been a firm believer in cash investments, a strategy that didn't pay off very well during the booming stock market of the 1990s.

But with the market treading water over the last year and interest rates hitting recent highs, Mr. Chesley, a 31-year-old budget operations analyst at a physicians' practice management group in Dallas, is looking a lot smarter.

" ... The further this market goes, the more skeptical I get and the more conservative I get," says Mr. Chesley, who has stashed 80 to 85 percent of his money in cash investments such as certificates of deposit and a money market mutual fund. "I've been a firm believer in cash."

He's not alone.

Cash investments, which have been overshadowed by the roaring stock market, are making a comeback.

"Everyone needs to have some type of liquid cash at all times, if nothing else than for just an emergency fund," said Greg McBride, financial analyst with bankrate.com, a Web site that tracks consumer interest rates. "The current environment is such that you're well-compensated by having that liquid reserve."


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Yields on certificates of deposit are at a five-year high, he noted. The average yield on a one-year CD in Dallas was 5.68 percent as of last Wednesday, compared with 4.67 percent a year ago – an increase of more than 17 percent.

That's pretty attractive when you consider that's a risk-free yield, because CDs carry federal deposit insurance (up to $100,000 per institution). It also compares favorably with the current annual U.S. inflation rate of 3.7 percent.

Yields on money market accounts, which are similar to savings accounts, are also attractive, although it may not seem that way at first glance at the Dallas numbers.

The average yield on money market accounts in Dallas was a puny 2.09 percent as of last Wednesday, compared with 1.99 percent a year ago, Mr. McBride said, "but it's certainly not difficult to get a yield that's well over 6 percent."

The highest money market account yield nationwide was 6.56 percent as of last Wednesday, compared with 5.37 percent a year ago, Mr. McBride said.

The government also insures bank money market accounts.

Yields on money funds, which the government doesn't insure, are also fat, although they're peaking, money fund experts said.

"They're the highest that they've been since April 1991, and we've pretty much seen the entire effect of the Federal Reserve's rate hike," said Peter G. Crane, vice president and managing editor of iMoneyNet Inc., which tracks money fund yields.

For the week ended last Tuesday, the highest seven-day compound yield among taxable, general-purpose money funds was Strong Investors Money Fund at 6.75 percent. (Compound yields assume reinvestment of dividends.)

Interest rates are high due to a series of rate increases by the Federal Reserve over the last year. Besides making cash investments more attractive, higher interest rates have been a drag on stock prices.

Anyone who invested in CDs a year ago, for instance, would have easily outperformed an investor in the stock market, at least as measured by the Dow Jones industrial average, which has fallen almost 3 percent over the last 12 months.

Of course, not many investment pros would advise that you try to time the market by pushing all your assets into cash securities just because you think stock prices are stagnant. Sitting in cash during a bull market can be hazardous to your financial health.

When you'll need it

Still, there's no reason not to join the Fed's yield party. But first, you need to determine your financial needs.

If you'll need your money in a short time, don't put your money in CDs because you have to lock up your money for a set period, such as six months or a year. If you withdraw the money before the CD term expires, you could forfeit as much as six months' interest, depending on the CD and the bank.

"If you don't know when you're going to need the money, you're better off in a money market fund or bank account because of the liquidity," Mr. McBride said.

Don't fall into the trap of believing that you can lock in a CD at a high rate of, say, 7.5 percent, and then cash out early and pay the penalty if you need the money before the CD matures.

"The reality is that when they cash out, that yield they would end up getting will be less than the original 7.5 percent on the CD when you factor in the interest penalty they have to pay, so it's not a favorable strategy," Mr. McBride said.

A good strategy to use with CDs is a method known as "laddering." This involves buying CDs with widely varying maturities, arranging them so that the maturities resemble rungs on a ladder.

The point is to have CDs mature on a regular and consistent basis.

"I may take some money out on a three-month basis, nine-month basis, one-year basis," Mr. McBride said. "For retirees, the benefit is that they have CDs that mature on a regular schedule so that they have a constant inflow of cash."

Mr. Chesley uses laddering to ensure that his CDs mature in six-month increments.

"That way, I'm always assured that if I had to get something, I would have that cash available to me," he said. "I have money coming at a consistent pace."

To find the highest yield from a CD or a money market account, shop around. But you may have to send your money out of town.

"The place to go to get the best yield for a money market account isn't necessarily at the bank across the street," Mr. McBride said. "The higher yields are being paid by small institutions, but these institutions are insured by the FDIC [Federal Deposit Insurance Corp.], so you have nothing to worry about."

Not for everyone

CDs aren't for everyone. Just ask Owen Arnold of Plano, who's selling his home and is trying to decide where he'll retire.

"CDs don't appeal to me because you're locked in and they're not liquid," said Mr. Arnold, 59, an accountant and director of tax at a large corporation. At the same time, he wants his money to be earning a decent return.

So he and his wife, a nurse, plan to put the proceeds from the home sale in a tax-exempt money market fund that invests in municipal bonds. That kind of fund pays dividends that are exempt from federal income taxes. Some also provide returns that are free of state and local taxes.

Mr. Arnold said a tax-exempt money fund would benefit him because he's in a high tax bracket: 36 percent.

"The yields are very attractive when I factor in my tax bracket," he said. "It comes close to what a CD would be and yet it gives me flexibility and liquidity and security."

Although money funds aren't insured by the government, they do have safety because the Securities and Exchange Commission imposes stringent portfolio quality, maturity and diversification restrictions on money funds.

"They're among the most highly regulated financial instruments in the world," iMoneyNet's Mr. Crane said.


Cash talk

Here are definitions of common cash investments:

Certificate of deposit or CD – An interest-paying deposit product offered by a bank that requires you to lock up your money for a certain amount of time. Maturities range from a few weeks to several years. Early withdrawal (i.e., before the maturity date) typically results in a forfeiture of interest. CDs are protected by federal deposit insurance.

Money market account [MMA] or money market deposit account [MMDA] – This is similar to a bank savings account. However, unlike savings accounts, a money market account often has transaction restrictions and offers check-writing privileges. Like a savings account, the funds can be easily accessed.

Money market accounts carry federal deposit insurance and typically pay higher yields than a conventional savings account.

Yield – Generally, the return paid to the holder of a security, such as a CD or a bond.
Annual percentage yield [APY] – The percentage, required by law to be disclosed on interest-bearing deposit accounts, that reflects total interest to be received, based on a financial institution's compounding method for a 365-day year.

Money market mutual fund or money fund – A mutual fund that invests in short-term debt instruments, such as U.S. Treasury bills and commercial paper [short-term corporate IOUs]. Money funds typically value the price of their individual shares at a constant price of $1. Money funds don't carry federal deposit insurance and usually offer restricted check-writing privileges.

SOURCES: Dallas Morning News research; bankrate.com.


Pamela Yip covers personal finance for The Dallas Morning News. If you have a story idea, e-mail her at pyip@dallasnews.com.