Perhaps the most common question we receive from clients is: Where can I find more income among cash alternatives? Unfortunately, there are few, if any, satisfying answers today. If an investor wishes not to take on risk, then he or she cannot expect to earn anything more than a nominal yield in todays environment. To find yield today, investors must take on risk. This is a deliberate consequence of current Federal Reserve policy.
There are three main risks for investors to consider when searching for yield cash alternatives.
- Liquidity Risk This is the risk that you will not have ready access to the money if you need it. Bank Certificates of Deposit are a good example. According to bankrate.com, the average 1-year bank CD pays 0.90%. This is meaningfully above the yield on money market instruments, but requires investors to forgo access to the money for a year, or face a penalty.
- Interest Rate Risk Interest rate risk is the threat that bond prices will fall if interest rates rise. According to Morningstar, the average short-term bond fund has a yield of 1.4%, but corresponding interest rate risk that suggests the possibility of a 2% loss should interest rates rise 1%.
- Credit Risk Investors may generate more income by investing in bonds issued by riskier entities. For investors who are considering alternatives to cash, however, this may be the least palatable type of risk.
An investor today may need to assume a significant amount of additional risk in order to obtain an incrementally higher yield. We believe it is better to accept a somewhat lower level of income today than to push the envelope in the search for income.