Cash can be a safe harbour

Investors interested in reducing the ups and downs in their investment accounts should hold a portion of their financial assets in cash at all times.

Increasing or decreasing this portion based on economic indicators and market conditions is prudent.  Cash can be viewed as a safe harbour, similar to a bank or savings account, and – within an investment account – provides the flexibility to purchase investments when good opportunities arise.

The greater your cash balance, the less your portfolio should fluctuate with changes in the stock market, including declines and upward rallies.  Finding the right percentage of cash is important so that you are comfortable with the other portion exposed to the markets.  Investors with cash when markets decline have the ability to take advantage of lower stock prices.

Capital preservation is one of the primary reasons to hold cash.  Cash balances may also fulfill income requirements, as they generally earn a predictable level of interest income.  The income is dependent on the type of investment, commonly referred to as cash equivalents.  Cash equivalents are considered low risk and liquid (less than one year to maturity).  The most common types of cash equivalents are:  money market mutual funds, treasury bills, high-interest savings accounts, and cashable guaranteed investment certificates (GICs).

Money Market

Money-market mutual funds were created in the U.S. in the mid-1970s.  Today, nearly all mutual fund companies around the world have a money market fund as part of their fund line-up.  Typically, money-market funds are the most conservative type of mutual fund.  New deposits (either lump sums or monthly pre-authorized contributions) and proceeds from stock sales may be put into a money market fund while you investigate new investment opportunities.   Investors contemplating money market mutual funds should consider these five points:

  • returns fluctuate and may be negative
  • investment returns are not guaranteed and are not CDIC insured
  • money market funds trade at $10 per unit
  • investors with mutual fund holdings are typically able to switch within the fund family (from an equity or bond fund to a money market fund)
  • some money market funds restrict their investments to government or government-guaranteed while others include a large variety of riskier type of investments, including mortgages

Treasury Bills

Treasury Bills, also known as T-Bills, are purchased at a discount to their future maturity value.  They are a popular way to hold cash equivalents for sophisticated retail investors but are used more frequently at the institutional level.  Canadian money-market funds (mentioned above) often invest in a blend of federal and provincial government treasury bills, high quality commercial paper, bank certificates of deposit, and bankers’ acceptances.  All of these short-term cash equivalents are considered to be relatively low-risk in nature. Mutual funds have large, constantly changing portfolios of these issues, and they are able to purchase T-Bills at wholesale rates.  This differs from investors who only have small amounts to invest, require periodic income, or don’t want to lock in their cash for a specified period.  The following are four points to remember about T-Bills:

  • generally guaranteed by the issuer (federal and provincial government)
  • funds are generally invested for a specific duration (i.e. 180 days).
  • T-Bills are not automatically reinvested and involve you providing reinvestment instructions
  • yield-to-maturity is known at the time of purchase

High Interest

Another type of cash equivalent investment is available which we will refer to as high interest savings accounts.  High interest savings accounts have competitive rates and are very liquid.  These trade on the same platform that mutual funds trade on but are different in a few key areas.  The following are the four key points to remember:

  • interest rates may be found on the respective companies websites and are subject to change (both up or down)
  • high interest savings accounts are generally guaranteed through CDIC insurance up to $100,000 per qualifying account and issuer, provided the investment is denominated in Canadian dollars
  • high interest savings accounts generally trade at $1 a unit
  • interest is accrued even if the investment is held for only a day.

Cashable GICs

Cashable GICs are considered cash because of their liquidity.  Non-cashable GICs offer a higher interest rate than cashable GICs for similar terms.  Often investors may have a combination of both cashable GICs and non-cashable.  The following are three points to note:

  • the rate on a cashable GIC is set for the term and is not subject to change like the high interest savings account
  • generally a cashable GIC must be held for at least 30 days to have the accrued interest paid if cashed
  • each GIC issuer is generally CDIC insured up to $100,000

There are some very good risk management reasons to split significant cash equivalent balances into different types and issuers.  One reason may be to take full advantage of CDIC insured investments (see www.cdic.ca for complete details).

Regardless of the type, you should ensure you are receiving the maximum return on your cash balances.  We caution investors to avoid chasing higher rates on alternative products that they do not understand.