Hiding from market volatility in “near cash” can be rewarding
You can’t blame any investor for reassessing their risk tolerance after Tuesday’s heartbreaking stock market selloff, when the tech-heavy S&P 500 and Nasdaq sank the most since June 2020.
As central banks aggressively tighten monetary policy to control inflation (possibly at the risk of a recession), times are uncertain for those who rely on the markets to grow their retirement savings.
But the biggest difference between the early stages of the pandemic and now is the availability of options for investors to cash in and head for the sidelines.
Karl Berger, director of Citadel Asset Management and a senior wealth management consultant, told BNN Bloomberg this week that it might be better to wait for central bank rate hike missions on cash-like instruments then yields increase with interest rates.
“It’s not a market where there’s an obvious trade or there’s an obvious thing to do and sometimes it just happens, and it’s best to stay away,” he said.
WHAT IS CASH?
There are several terms for cash-like instruments; quasi-currency, quasi-currency, cash equivalents, arm’s length cash or cash equivalents.
The only thing they have in common is safety and performance. You won’t get rich with cash, but you won’t lose it either.
To put it into perspective; cash equivalents are one of the best performing asset classes so far this year if you compare the two or three percent returns to the roughly 19 percent loss in the S&P 500.
Cash equivalents, along with other fixed-income investments, are an amazing way to stem stock losses and preserve the value of a larger portfolio.
The difference between cash equivalents and any other fixed income is its high liquidity. It can be quickly converted into cash when other investment opportunities arise.
WHAT ARE THE YIELDS OF NEAR CASH?
The “closeness” of cash depends on the length of its term to maturity.
The closest money is money in your pocket – it’s ready to go, but it brings zero returns. This is the same as a standard cash account, which earns almost zero.
The next closest cash is probably a high interest savings account. You’ll have to shop around, but some financial institutions show 3% per annum – assuming certain conditions, such as minimum deposit amounts, are met.
High interest savings accounts are like all other savings accounts without the bells and whistles and can be transferred immediately.
Money market funds are popular with many investors who are waiting to pounce on the next opportunity. It is a type of mutual fund that invests in highly liquid short-term instruments, such as cash equivalent securities and short-term debt securities with a high credit rating.
Past returns for money market funds have been dismal, but can be expected to rise with interest rates.
In most cases, investments in money market funds can be liquidated within a day or two.
Generally, yields increase as the term to maturity increases. If you have more time to spare, some one-year guaranteed investment certificates (GICs) have hit 4.5%.
Yields on longer-term GICs are slightly higher, but risk being eclipsed as general interest rates continue to climb at an unprecedented pace. For this reason, many investment advisors recommend staggering maturities over time to take advantage of higher rates as often as possible.
NEAR CASH: RISK AND REWARD
Assuming you are in cash to avoid risk, it is important to ensure that your cash-like instrument is invested with a financial institution insured by the Canada Deposit Insurance Corporation. CDIC is a federally backed Crown corporation that covers deposits up to $100,000 in each account.
Most Canadian financial institutions pay premiums to be insured with CDIC, and members are listed on the CDIC website for all to see. Members include banks, federally regulated credit unions and trust companies. All major Canadian banks are members as well as non-financial companies with financial branches like Canadian Tire Corp.
If a CDIC member fails, eligible account holders will be contacted and principal and interest will be refunded within days. The latest CDIC member failure was Security Home Mortgage Corp. in 1996.
Savings and chequing accounts are covered as well as GICs and other term deposits with an original term to maturity of five years or less.
This does not mean they are risk free. With the cost of living currently over 7%, there is no inflation protection.