Personal Finance: Allocating your investment bucket

photo Chris Hopkins

Q: Can I earn a better return on my short-term cash?

A: No.

Actually, the question is a good one that highlights a fundamental step that should be taken in formulating investment plans: segregating assets according to the applicable time horizon. All other decisions ultimately derive from this critical exercise.

As a starting point, divide your investable assets into two buckets: long-term and short-term. Then, relabel the two buckets as follows: investments (long-term) and cash (short-term). That distinction can be helpful in assessing appropriate vehicles and expected returns for the respective portions.

Assets set aside for long-term goals can properly be classified as “investments”. Generally, one must be prepared to retain an investment for a minimum of three to five years in order to justify the risk attendant in holding stocks, bonds, real estate and the like. In order to realize a reasonable return over a holding period, an investor must tolerate losses from time to time, hence the need for a longer horizon.

Short-term capital is a horse of a different color. Money set aside for specific purposes in the near future, like college tuition, a down payment on a home, or an emergency fund, should not be subjected to potential loss. Don’t think of these funds as investments seeking a gain, but rather as cash to be protected. In the current low-yield environment, that means accepting a trivial return in exchange for safety and liquidity.

FDIC-insured bank CDs lack pizzazz but offer security and flexibility. A little spade work can turn up a 3 month CD that yields about a half percent, and one-year certificates can approach 1%. Given the likelihood of higher rates in the near term, keep the maturities short (one year or less); this will allow you to roll into higher-yielding instruments as the old ones mature. And bear in mind that you will most likely forfeit part of your interest if you cash out early, another point in favor of staying short.

If you are up for a little more effort, investigate some of the higher-yielding insured money market accounts. These are not the money market mutual funds offered by fund companies and brokers, but FDIC-insured depository accounts that pay interest and allow a limited number of transactions per month. Sallie Mae (the student loan company) offers a 0.90% yield with no monthly fees and insurance coverage up to $250,000. Other banks have competitive offerings as well; check out to peruse additional choices.

Avoid the temptation to stretch for a little extra yield at the expense of security. Stay away from short term bond funds, for example, if you want to count on having the cash available when you need it. The additional income is insignificant compared to the risk of coming up short on Junior’s tuition payment. And with rates this low, it’s simply not worth much effort.

Don’t think of your short-term stash as an investment. Focus on safety and availability, and then train your investment acumen on your long-term assets.

Christopher A. Hopkins, CFA, is a vice president at Barnett & Co. in Chattanooga.

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