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Subject:  Cash-Management Date:  9/6/2012  4:25 PM
Author:  trader2012 Number:  34358 of 36623

I just spent a couple of fruitless hours, scanning the bond offering-lists, trying to find something to buy. But these are problems I’m running into. Either I already own as much as is probably prudent for my account, or it’s not offered in a size small enough for my account, or it doesn’t offer a real-rate of return even when discounted by just a 5% inflation-rate. When the bond-shopping becomes an exercise in frustration, then I switch over to other tasks, like strategizing. This led me to wondering how I was allocated with respect to cash. That led, obviously, to trying to identify the reasons why I carry cash. Others will slice the categories differently, but these are my current allocations:

% of Assets Effective Yld
Cash for Place Holding 0.2% 0.0%
Cash for Emergencies 3.6% 3.0%
Cash for Investing 3.5% 0.0%
Total Cash 7.4% 1.1%

Bond Investments 92.6% 9.4%

Total Portfolio 100.0% 8.8%

Placing Holding is an awkward column heading. But its meaning is readily understood. Most accounts (deposit or otherwise) require that a minimum-balance be carried, or else a monthly fee is imposed. The cash could be withdrawn if it were really needed. But doing so would just create cascading problems. So it’s ‘dead cash’ that cannot be spent. But, also, it typically doesn’t earn any interest.

Emergency Cash is self-explanatory. Every household needs to be able to cover their likely-most contingencies, such as needing a new car or making the co-pays due from a hospitalization. For having just bought a car and for being in excellent health, I wouldn’t carry as much of an E-fund as I currently do except for the fact of being able to get a reasonable rate of return on it from my Credit Union. Several times in the past, I’ve taken my E-fund down to zero when compelling investment opportunities presented themselves. But that currently isn’t the case.

Investing Cash is a self-explanatory term. It's the money sitting in brokerage accounts waiting to be spent. Typically, it pays no interest. I’d spend every penny of it if I could find something worth buying, and I'd even go on margin. But it’s been a long, long time since I’ve needed to do that. The net-effect is that I’m currently carrying far more cash than I prefer. And the reason I prefer not to carry cash is that it pays so poorly and, thereby, creates risk. Yes, cash is free of ‘default-risk’. But it is fully subject to ‘inflation-risk’, meaning, to sit in cash is to let one’s purchasing-power erode.

Investments For over a decade now, I’ve run pretty close to an all-bond portfolio. Sometimes, as part of a Chapter 11 workout, I’ll end up with stock shares, or, sometimes, I’ll run investing experiments that have me owning stocks, options, or futures. But by and large, these tend to be short-lived projects that never exceed 1% of AUM.

Contrary to reports from the BLS that inflation is running at sub-2% (or whatever the latest CPI figures are), most households are experiencing an inflation-rate in the neighborhood of 5%-6%. When that is combined with their effective Federal and State tax-rates, it can easily be seen that their portfolio needs to return something in the neighborhood of 8%, just to break even after taxes and inflation. Therefore, every dollar of cash that offers 1%-2% has to be made up elsewhere in the portfolio by investments offering at least 14%-15%, or 150% of the average, long-term rate that stocks offer and twice that of bonds.

In other words, the putative safety of cash has to be offset by taking on high risk elsewhere in the portfolio. Thus, the less cash that can be carried, the lower the average risk that each investment has to be. In other words, I’ve got nothing against seeking and accepting high returns (e.g., 50%-100%) when they can be found priced with a reasonable margin of safety. But they aren’t common enough to depend upon. Instead, individual bond position returns tend to cluster in the mid-ranges of 7% to 9%. So the less cash I carry, the easier it is for me to meet my 8% benchmark (and sleep at night).

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