Equity markets have come roaring back from this week’s selloff and this summer’s correction. They always do.
It certainly won’t be the last buying opportunity for investors banking up cash for the next stock market plunge, but it might take some time. That’s why it’s important to keep that cash working by squeezing out the highest possible yields while you wait.
The formal term is “near cash” or “arms-length cash” and there are several ways to maximize short-term returns depending on how much you have socked away and when you need it.
Investment advisors recommend always having a portion of your portfolio in cash for potential bargain hunting expeditions, but the waiting game could be a lost opportunity in itself.
The recent spike in interest rates has presented opportunities to not only generate higher returns on cash, but for cash to act as a hedge against further equity market volatility.
High-interest savings account
If you want to be ready to pounce at any moment, your cash needs to be as liquid as possible. The best, and most common form of near cash is a high-interest or high-yield savings account.
Most investment firms offer them and it’s just a matter of transferring the cash within the portfolio when you need it.
The interest rate they offer is known as the annual percentage yield, or APY. It is expressed as an annual yield but calculated for shorter periods of time.
The yield can be ten times higher than a regular savings account, which pays close to nothing. The rates on some high-yield savings accounts currently top five per cent.
Yields are normally highest for large amounts of cash.
Money market funds
On the downside, the rates offered on high-yield savings accounts are variable and subject to change daily. And with the Bank of Canada currently slashing its benchmark interest rate, yields on savings accounts are in decline.
One way to automatically access the best short-term yields is through money market funds. They are a kind of mutual fund that invests in highly liquid, near-term instruments such as cash equivalent securities and short-term debt-based securities with high credit ratings.
In most cases, investments in money market funds can be liquidated within a day or two.
Returns on money market funds also fluctuate, but they can squeeze out the best going yields as broader interest rates decline.
The downside to money market funds are annual fees based on a percentage of the amount invested, which can top a full per cent. That fee, or management expense ratio (MER), is deducted from the yield but could still top a high-interest savings account.
Guaranteed investment certificates (GICs)
Higher yields require longer commitments. Another way to keep income flowing at a higher rate is through fixed term guaranteed investment certificates (GICs).
Yields on one-year GICs posted by the major providers have slipped just below five per cent almost in tandem with the Bank of Canada rate cuts and have likely topped out for the time being. This might be the last opportunity for short-term yields this high if you don’t mind waiting.
One strategy to keep the income stream flowing is to stagger maturities.
Not all near-cash is risk free
Assuming you are in cash to avoid risk, it’s important to be sure your near-cash instrument is invested through a member financial institution insured by the Canada Deposit Insurance Corporation (CDIC). The CDIC is a crown corporation supported by the federal government that covers deposits of up to $100,000 at each financial institution.
For that reason, it’s a good idea to limit deposits to $100,000 at one financial institution.
Most Canadian financial institutions pay premiums to be insured with the CDIC and members are listed on the CDIC website for anyone to see. Members include banks, federally regulated credit unions and trust companies. All the big Canadian banks are members along with non-financial businesses with finance arms.
If a CDIC member fails, eligible account holders will be contacted, and the principal and interest will be reimbursed within days.
Savings and chequing accounts are covered along with guaranteed investment certificates (GICs) and other term deposits with original terms to maturity of five years or less.
That doesn’t mean they are risk free in the real world. There is no guarantee inflation will not outpace your return.