When A Duck Is Not A Duck
Recently, more than a few people mentioned to me they had found vehicles comparable to cash but with significantly higher yields. A few weeks ago I was told by another advisor there are many good alternatives to cash if you know where to find them; when I expressed my concerns, the advisor refused to provide details and abruptly ended the meeting; apparently I asked to many questions. It’s time to share a few thoughts on the ease with which higher-yielding so called “cash alternatives” can be found.
True cash – with immediate liquidity and no nominal value risk at any time – exists in only one form: bank demand deposits. (True, there is also plain currency, but that is really not the form in which any of us keeps substantial cash reserves.) Other forms of “cash substitutes” have one or more qualifications that nullify, at least in part, the essence of true cash – and explain why the returns can be higher. In other words, these other forms are not cash.
The most typical additional qualifications employed – but not necessarily fully understood or valued – are:
- Liquidity limits caused by the salability of the purchased vehicle.
- Accessibility risk, or the ease with which you can get at your cash; see money market funds.
- Size issues in terms of the minimum amount to be invested.
- Credit risk linked to the institution providing or the structure employed in the vehicle.
- Time or maturity risk often in conjunction with penalties for early withdrawals.
- Transparency risk linked to the structure or security purchased.
- Political risk linked to the country or jurisdiction providing the alternative.
- Active management risk necessary to generate the higher returns, often with help from all of the above.
For completeness I should mention that demand deposits are not all created equal; my readers from Cyprus – if any – know that only too well. And who can guess what other marvels of negative surprises will the future bestow upon us? But in general – and especially if your cash holdings are within the national insurance limits – demand deposits are considered safe alternatives to having a huge stack of bills under your bed.
So, to inversely paraphrase a well-known saying (“If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.”), if the returns look too good then it’s probably not cash. And beware of advisors who offer you many alternatives; you should point to the obvious fact all other investments are cash alternatives, but they may not be cash substitutes.
Best wishes for a cash-full and prosperous New Year.
Photo source: Wikipedia, “Duck Test”
