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QUARTERLY INVESTMENT OUTLOOK AND FUND REVIEW

Cash Is King This Year as Its Returns Beat Big-Company Stocks

October 09, 2000|KATHY M. KRISTOF | TIMES STAFF WRITER

Call it the revenge of the risk averse. For years, experts have been pushing sometimes reluctant investors into stocks, contending that you'll never get a decent return if you don't take a little risk. But, this year, risk hasn't been particularly rewarding.

So-called cash investments--liquid, low- and no-risk securities such as Treasury bills, bank certificates of deposit and money market mutual funds--were the hot spots for better-than-average returns in the third quarter, with a return of more than 4% year-to-date. That handily beats the S&P 500 stock market index, which was down 1% for the quarter and 1.4% for the first nine months of the year.

"This is proof of the pudding that asset allocation works," says Clay Singleton, vice president of asset allocation consulting and training at Ibbotson Associates, a Chicago-based market research and consulting firm.

The idea behind asset allocation--market shorthand for spreading your money among different "classes" of investments such as stocks, bonds, cash and international securities--is that when one type of investment declines in value, another rises. If you own them all, your entire investment portfolio is more stable and profitable.

But the cash component in that asset allocation model has suffered during the past five years as the stock market went on a near record tear, and investors began to question whether it made sense to hold low-yielding cash investments, even for short-term goals. However, what many investors fail to realize is that while stocks do outperform all other investment classes over long periods, in the short run, the picture isn't as clear.

In fact, cash investments--as represented by the 30-day Treasury bill--have beaten the performance of big company stocks in 26 years out of the 73 that Ibbotson tracks, or about one-third of the time. Unfortunately, like now, cash tends to beat stocks in miserable years, when stock prices are languishing.

No one advises that you change your asset allocation strategy based on cash's good recent performance. Some cash belongs in every portfolio because it is simply the best investment available to address important short-term goals.

"The amount of cash you ought to hold is going to depend on your time horizon and risk tolerance," says Greg McBride, financial analyst with BankRate.com. "In a year like this, the lack of performance from stocks and the fact that cash investments such as CDs and money markets have performed so well, makes a great argument for diversification. But it shouldn't change your strategy."

The good news is that cash investments today are paying considerable "real," or after-inflation, returns.

Consider, for example, the rate you can earn on a simple checking account, if you agree to bank over the Internet. American Bank in Allentown, Pa., pays 6.06% compounded daily on checking balances of up to $10,000. Since you get interest on top of interest, the annual percentage yield works out to 6.25%. Although that rate can vary at the bank's discretion, it's been at this level for about a year.

If you're willing to lock up your money a little longer, the returns are richer. Charter One bank in Cleveland, for example, will pay 6.75% on a 7-month certificate of deposit. If you agree to leave your money deposited for a year, you get 7%; if you lock it up for two years, you'll get 7.25%.

The one caveat to putting your money in an out-of-town bank is that investors must be sure they are dealing with a bank that's insured by the Federal Deposit Insurance Corp., a government entity that stands behind bank deposits of up to $100,000. And, they must be sure that they are depositing money in a bank account, rather than "investing" in a security that doesn't offer FDIC protection. That guarantees that you'll get your money back, with interest, to the magic $100,000 mark, even if the bank you're dealing with fails.

How do you know whether a bank is FDIC insured? Most banks emblazon the FDIC logo on their Web sites and in their statements. Some even link to the FDIC Web site, where you can double-check that your bank is insured.

You can also rate shop at the BankRate.com site, which checks out all the institutions it lists for safety, soundness and FDIC coverage. That site is at http://www.bankrate.com.

Want a money market fund? Money funds invest in low-risk short-term securities, such as bank deposits, Treasury bills and commercial paper. These funds typically give you immediate access to your cash, often through check-writing privileges. And yet, they are also paying relatively generous real returns, with the top-paying funds posting annual yields of up to 6.7%.

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