I published a version of this article twice previously, the first in early 2016 and the second in the fall of 2017. Over time, the options for stashing a pile of cash and getting a decent return have become fewer. Today, the options are truly slim. This is one of those times when the stock and bond markets just will not cooperate with our investment plans and goals. The Dow and S&P market indexes are pushing all-time highs after nearly 11 years of a bull market. The Nasdaq has already recently set an all-time high and bond yields are near all-time lows. While this is great for investors that were already in the bond and equity markets, it is a tough environment for finding and making new equity or bond investments today. Under these conditions, what is an investor to do to park excess cash?
There are a couple of Warren Buffett quotes that come to mind that I believe are applicable to our current environment. The quote below is one that speaks to being highly selective in making your investments.
“I call investing the greatest business in the world … because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There’s no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.”
The quote above is from 1974, and today, GM (NYSE:GM) is selling for around $25 per share and US Steel (NYSE:X) is selling for under $7. It was certainly to Buffett’s advantage to let those two pitches go by without taking a swing. Buffett’s advice is even more applicable today with the markets at or near all-time highs with the possibility of a deep and long recession during the next 12 months. My translation of Buffett’s quote above is to be very selective going forward with new investments. The other Buffett quote that is applicable today is about seizing opportunity.
“Be fearful when others are greedy and greedy when others are fearful.”
My way of interpreting this second quote is to take a step back from investing or trim your positions when investors are bidding equities up into a froth. The other side of this same quote suggests that you should be ready to invest when other investors are running from the market and driving the prices of equities down. The less elegant translation is “sell high and buy low”. Today, I believe we are in the former situation of having high and increasing equity valuations with potentially poor returns over the next few quarters. So, where should an investor put their idle cash while waiting for the market to offer better valuations?
Where to Stash Your Cash
Everyone should have some cash on hand whether to cover emergency expenses, six months of living expenses, or when you just don’t want to commit more money to stocks or other long-term investments. For the past couple of years, the interest rates offered by the big banks and brokerage houses on their traditional money market funds and other deposit savings vehicles have been nothing short of abysmal, averaging about 0.1%. This is just about the equivalent of putting your money into a Mason jar on the kitchen counter or under the bed mattress. My philosophy is that all your money should be working for you all of the time. For me, 0.1% just doesn’t cut it as an adequate return on my cash assets. There are better alternatives for where to stash your cash but the options have become fewer.
Option 1 – Short-Term Bond Funds
One option is to use short-term corporate or municipal bond funds. These funds typically invest in bonds with maturities of three years or less. As long as you pick a fund that invests only in investment-grade paper, the credit risk is negligible. However, market risk (rising rates) is still an issue but mitigated by the very short maturities of the bonds that make up the fund. All of the major fund families (e.g. Vanguard, Fidelity, T. Rowe Price, etc.) have short-term bond funds. Pick your favorite family, but be cognizant of the expenses/fees that management takes to manage the fund as this can materially lower your returns. I have used both Vanguard and Fidelity. Both are excellent fund families and you would not go wrong with either. I prefer Vanguard as it has some of the lowest management fees in the industry. The two Vanguard short-term bond funds I have used the last few years are listed below:
As of today, the SEC yield on the corporate bond fund is down to 1.33%, and on the tax exempt bond fund, 0.58%. The management fees are 0.1% and 0.09% respectively. The average maturity of the bonds in VFSUX is 3.1 years versus 0.8 years for VWSUX. The current yield on VWSUX reflects this very short average maturity. The Federal Reserve has already stated clearly that short-term rates are going to be kept low through 2021, so there is not much market risk to worry about. The current yields pretty much reflect a very low risk environment. There is the possibility of some additional capital appreciation if the Fed or the market pushes rates even lower, but I’m not banking on that. I’m not parking any cash in either of these options as I expect the return will be subpar.
Option 2 – Ultra Short-Term Bond Funds
In 2015 Vanguard opened a new bond fund to specialize in ultra short maturity bonds, typically with maturities between 0 and 3 years. This new fund doesn’t yet have the same economy of scale working for it as does VFSUX. The Vanguard Ultra Short-Term Bond Fund (MUTF:VUSFX) carries an average maturity of one year, a current SEC yield of 1.08%, and a management fee of 0.11%. I’ve not personally used VUSFX but I may make use of it in the future. The advantage of ultra short maturity bond funds is that they are not very sensitive to interest rate fluctuations and provide better capital preservation in a rising rate environment, an environment we are not likely to see for some time.
There is a potential drawback to using any of the Vanguard funds listed above. Many and maybe all Vanguard funds other than their traditional money market funds include frequent trading restrictions. After making a redemption from the funds listed above, the investor may not purchase additional shares of the same fund within a 30-day period. I’ve found it workable over the years by using more than one Vanguard fund for stashing my cash.
Option 3 – Online Banks
The other alternative I have made extensive use of in the past and currently use to a smaller extent is online banks. These banking institutions exist online as websites. Some have brick and mortar retail banks but online banking you can do from your own home. The online banks don’t offer all the services that are provided by your local brick-and-mortar banks, but they also have a lower operational cost structure, allowing them to offer better rates on deposits. The online banks offer traditional money market accounts, high-yield savings accounts, and certificates of deposit. I’ve compiled a list of those online banks that offer the highest interest rates and have good ratings for problem-free transactions and attentive and helpful customer service staff. All are FDIC insured and all are rated at least 4 star by Bankrate.com.
I have used all of the banks listed above and found each website to be easy to use and the bank’s customer service organization to be helpful. Using Automated Clearing House electronic funds transfers, I can move money to and from any one of the banks to my brokerage settlement account in 2-3 days and the transfer is free of charge.
Not a bank but a money market fund, the Vanguard Federal Money Market Fund (MUTF:VMFXX), currently yields a whopping 0.10%. The savings account rates in the table above are up to 10x higher. On a relative basis, the bank rates look great compared to the Vanguard Prime money market fund. If you are letting your cash account sit in a standard money market account or brokerage settlement account currently, the above list of online banks provides a much higher-paying alternative. You are also getting FDIC insurance and, with the CDs, you are getting a guaranteed rate for the CD term. I still have existing CDs yet to mature in the institutions listed in the table above, but I don’t plan to roll the CDs over at the current piddling rates when they mature.
A Non-Traditional Option
I’m taking the approach of reducing the overall risk in my portfolio and rotating out of higher risk equities in favor of lower risk equities. For example, I’ve recently rotated out of growth and small cap stocks in favor of, what I consider, more recession resistant stocks including AT&T (T), Altria (MO), British American Tobacco (BTI), and Williams Companies (WMB). These companies pay a decent dividend and their products and services are generally recession resistant, but I don’t expect to see much in the way of capital appreciation. But I also need a place to hold cash while I’m de-risking my portfolio.
With short-term bond rates, bank CDs, and money market rates as low as they are today, I decided to look at non-traditional options for stashing my cash while I wait for equities to become sensible investments again. I looked at a number of possible options including enhanced yield closed end funds, utilities, REITs, high yield bond funds, and various exchange traded funds. I settled on high-grade (credit rating) preferred exchange traded funds, and in particular, the iShares Preferred and Income Securities ETF (PFF) and the Invesco Preferred ETF (PGX). Both funds are well diversified with a large fraction of holdings from companies with investment-grade credit ratings and are highly liquid with large volumes traded daily. The iShares offering, PFF, is larger, better diversified, with a larger percentage of holdings from entities with investment-grade credit. However, PGX’s dividends are somewhat more tax advantaged with a higher percentage of the dividends being qualified dividends. PFF currently yields about 5.7% and PGX about 5.5%.
Both PFF and PGX have very low betas and prices are therefore very stable. While PFF/PGX are not typically considered a repository for short-term cash holdings, in the current financial environment we have today, I’m happy to have this non-traditional alternative for cash holdings.
When the market turns frothy, it is paramount to select your investments very carefully. Short-term bond funds and online banks provide a safe and conservative alternative to parking your spare cash in your brokerage settlement fund or a standard money market fund, but in today’s environment, only provide minimal returns. Investors should consider non-traditional options for holding cash while waiting for the market to return to investable valuations. PFF and PGX offer two possible non-traditional options for parking your excess cash.
Disclosure: I am/we are long MO, WMB, BTI, T, PFF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: This article is intended to provide my opinion to interested readers and to serve as a vehicle to generate informed discussion in the comment posting. I have no knowledge of individual investor circumstances, goals, portfolio concentration or diversification. Readers are strongly encouraged to complete their own due diligence on any stock, bond, fund, or other investment mentioned in this article before investing.