No. of Recommendations: 5
Each investor will have her own reasons for creating savings, chief among which might be the psychological anchor that savings provide, as well as the financial discipline instilled. The growth of one's money is “A-Good-Thing” and certainly a tactical benefit of savings. But the more important benefit might those aforeward-mentioned, strategy ones of stability and discipline. So, I would claim that savings are “A Good Thing” just for their own sake. But that's for each investor to decide.

So, also, might the same things be said of reserves, which seem to serve two purposes. The first is an aggregation process, whereby small amounts of cash from disparate sources are gathered together into a quantity sufficient to be deployed as a single unit. Discussing that will be the main purpose of this post. But, first, I want to comment briefly on the second purpose and then take it up again at another time. Also, there are likely to be yet other purposes for reserves, and I invite everyone to share what he is doing.

The second purpose for creating and carrying reserves is risk management, whereby cash is always carried in one's portfolio in a sufficient quantity to overcome the maximum anticipated draw-downs to that portfolio such as might be caused by multiple simultaneous failures, or a sustained sequence of failures, of the individual positions in the portfolio. In other words, if the risks of a portfolio are properly managed, it is possible to sustain even significant losses without compromising the integrity of the program underlying the portfolio or the investor's will to keep moving forward with the program. But as losses mount up, at some point they begin to cripple both the ability and the will to make new investments. Therefore, the purpose of reserves is to ensure that point is never reached, much less the far worse one of destroyed the portfolio, which was exactly the failure of Long Term Capital Management. They failed to carry sufficient reserves, and the story is instructive.

Some smart-*ssed, Nobel-winning, financial whiz kids, classic academics everyone of them, who could admittedly price risk better than anyone in the whole world, failed to listen to their own traders who had an intuitive sense that LTCM was over-leveraged and that the fund was not carrying sufficient reserves. The academics argued to the traders that the feared event, all open positions failing simultaneously rather than an in an orderly and manageable way, was a statistical improbability. But, as financial history tells, “fat tails” do happen, and the academics blew up the account. Despite the efforts of the traders to unwind the risks, the losses, once they started happening, were cascading and unstoppable.

I keep hammering on the LTCM incident because Wall Street's whiz kids have done it again. They've once again created a leveraged situation that could take down the whole financial world, and you, the average, small investor, will be paying the costs of their arrogance. I'll post the links to some of the relevant articles separately. But they are in plain sight and easy to find on your own if you're making even half an effort to do the things a fixed income investor has to do in order to anticipate and avoid troubles. Despite's the White House cheerleaders who can point to a lot of positives about the US economy, those positives are like a sea gull who has momentarily landed on an iceberg. The tip of the iceberg seems like a stable perch, but the supporting mass of the berg is rotten ice and being rapidly eroded by the seas. The deficits and debts the US is running are unsustainable. Fixed-income investors are riding a train headed for a wreck.

The “average small investor” isn't likely to ever to find herself paralleling LTCM in scale or technique. But I would claim that she has no less of a responsibility to herself to anticipate the worst possible case and to defend her portfolio against it, which can be accomplished (among other things) by carrying sufficient reserves. What “sufficient” might mean will be for each person to determine.

OK, let's return to a fairly non-controversial use of reserves, which is Cash Aggregation. If you're an active fixed-income investor with even the most modest of portfolios, you are constantly faced with the task of putting back to work tiny, little income streams from periodic interest payments; coupon payments; instrument redemptions, calls, sales; etc. Constantly, tiny bits of cash are dribbling into your accounts. One way to deal with the money is to spend the money your money has made for you and just put the principal back to work again. Another way to deal with the bits of cash is to aggregate it and then redeploy it as a unit. (And I'm sure there are other paths that could be followed and invite you to speak to that point.)

What I've been trying to work out for myself over the past couple of days is an easy and effective way to aggregate cash. What I keep re-discovering is that an information source like is indispensable and possibly without peer. If you want comprehensive information on who in the nation is paying the highest rates across a wide variety of instruments, you need to look no further. For sure, there will always be localized exceptions, as one poster reported, whereby one particular bank was offering to those living in a restricted number of zip codes CD rates that were well above the competition. But those sorts of opportunities are typically evanescent. Instead, if you're trying to put together a cash aggregation program, you want sources of information that cheap or free, readily available 24/7, totally reliable, etc. Furthermore, you want the institutions with whom you are dealing to be cheap or free in terms of fees, readily available 24/7, as reliable as is possible, etc.

Requiring that institutions be “reliable” brings up the topic of bank ratings, which is yet another topic about which I do not know as much as I should. (If anyone has special knowledge, please share it with us.) On their web site, BankRate offers a brief description of the proprietary process by which they rate banks using a 1 to 5 star system (with 5 stars being “superior strength” and 3 stars being merely “performing”). It has become my practice to avoid institutions with less than a 4-star rating. What cutoff point you choose for yourself will be for you to choose. But let's say you also decide to stick to 4-star banks. Who is currently paying the top rate for small accounts? GMAQ Bank, right? at 4.3% APY. (4.21% is their daily rate.) That sounds fat and better than the Treasury Department's 4.13% for 4-week T-bills. But your gains from GMAC will be subject to both Federal and State taxes, whereas your gains from Treasury obligations might be exempt from State taxes. (That is something each investor will have to determine for herself.) But it might well be the case that aggregating cash at GMAC into amounts sufficient to buy 4-week T-Bills through Treasury Direct and then aggregating those T-Bills for further deployment (and better yields) is a good strategy to pursue.

I don't want to grind through the tactics of such a process, which is going to vary according to the situation of each individual. I simply want to suggest that BankRate and Treasury Direct might be a good pair of tools with which to begin the process of managing cash and creating reserves.

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Is it me, or was the that longest-winded, most technical description of why to have an emergency fund and where to keep it that I've ever seen?

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A Rebuttal to DeltaOne81:


If you think the topic is so obvious and my execution so inept, show me that you can do better. From 01/01/1997 to present, you have posted 21 times to this discussion board, 6 post of which were topics you initiated, and 15 were just kitbizing.

Do you limit your posting because you know it all already, or because you mere have nothing meaningful to say?

Don't ever jump into one of my threads again.

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No. of Recommendations: 5
Don't ever jump into one of my threads again.

Get a sense of humor :-P
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