Some Thoughts About Allocating to Cash
Thursday, July 19, 2018

One of the Briefly Noted columns appearing in next month’s AAII Journal will give tips on what to do during each of the five years leading up to retirement. In the column, we reference AAII founder James Cloonan’s Level3 withdrawal rules. Among those rules is allocating an amount equivalent to two to four years of planned withdrawals in so-called safe investments, otherwise known as cash equivalents.

Allocating to cash—and equivalents such as certificates of deposit (CDs) and Treasury bills—won’t make you rich. It will also reduce your purchasing power—the ability to buy goods and services with the money you have—over time because of inflation. What cash does provide is a source of safety and liquidity. When an emergency occurs or things go haywire in the stock market, having access to cash can come in handy. This need for liquidity and safety should be balanced with the need for portfolio growth.

Cash can also help you handle more risk in your overall portfolio. Financially, it protects you from having to sell securities at depressed prices when the market is down. Psychologically, it can give you the confidence of knowing that, no matter what happens in the market, your shorter-term expenses are covered.

How much cash should you hold onto? It depends on your needs. Two useful rules of thumb are six months’ to one year’s worth of expenses for those who are working and four years’ worth of planned withdrawals for those nearing or in retirement. Amounts needed to cover other large expenditures within the next few years should also be maintained in cash. Beyond that, long-term investors should put the cash to work in assets with higher levels of potential return, such as stocks.

In terms of where to put your cash, you have options. Traditional checking accounts and brokerage sweep accounts often pay relatively little interest. (Depending on the size of your account, there may be perks and services that make enduring the low interest rates worthwhile.) Beyond what you need for spending or require quick access to, put the money elsewhere. lists several online savings accounts paying yields of 1.70% or higher. Through a royalty program with us, Discover is offering AAII members 1.80% on savings. Three-year CDs with annual percentage yields of 2.55% are also currently available. When looking at bank savings accounts and CDs, confirm that they are FDIC insured. The standard insurance amount is $250,000 per depositor, per insured bank, for each account category.

Money market mutual funds from Fidelity, Schwab and Vanguard (and likely other companies) have yields currently ranging between 1.5% and 2.0%. These funds generally are insured by the Securities Investor Protection Corporation (SIPC) for up to $500,000. (SIPC insures actual cash balances only to $250,000.)

Treasury bills are another option. They can be purchased directly from the Treasury Department at The two-year note closed today with a yield of 2.59%.

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Highlights from this month's AAII Journal

AAII Model Portfolio Update

No changes were made to the Model Shadow Stock Portfolio this month. The next quarterly review will take place at the end of August.

The AAII Model Shadow Stock Portfolio, which is a real-money portfolio of micro-cap value stocks, gained 2.35% in June. The Vanguard Small Cap Index fund (NAESX) added 0.72% for the month, and the DFA U.S. Micro Cap fund (DFSCX) gained 1.40% in June.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 15.6% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.4% per year on average. Over the same period, the Vanguard Small Cap Index fund (NAESX) posted an average annual gain of 10.4%.

The Week Ahead

The earnings floodgates are going to deluge the market next week with 182 members of the S&P 500 index scheduled to report. Included in this group are 11 Dow Jones industrial average components: 3M Co. (MMM), United Technologies Corp. (UTX) and Verizon Communications Inc. (VZ) on Tuesday; Boeing Co. (BA), Coca-Cola Co. (KO) and Visa Inc. (V) on Wednesday; Intel Corp. (INTC) and McDonald’s Corp. (MCD) on Thursday; and Chevron Corp. (CVX), Exxon Mobil Corp. (XOM) and Merck & Co. Inc. (MRK) on Friday.

The week’s first economic report will be June existing home sales, which will be released on Monday. Tuesday will feature the July Purchasing Managers’ Index (PMI) Composite Flash. June new home sales will be released on Wednesday. Thursday will feature June durable goods orders and June international trade. Friday will feature the first estimate of second-quarter gross domestic product (GDP) and the University of Michigan’s final July consumer sentiment survey.

The Treasury Department will auction $35 billion of two-year notes Tuesday, $18 billion of two-year floating rate notes and $36 billion of five-year notes Wednesday and $30 billion of seven-year notes Thursday.

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AAII Sentiment Survey

The percentage of individual investors describing their short-term outlook for stock prices as “neutral” rebounded strongly in the latest AAII Sentiment Survey. Optimism pulled back, as did pessimism.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 8.4 percentage points to 34.7%. The drop puts optimism back below its historical average of 38.5% for the third time in four weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, jumped by 12.6 percentage points to 40.4%. Neutral sentiment was last higher on May 16, 2018 (42.7%). The historical average is 31.0%.

Bearish sentiment, expectations that stock prices will fall over the next six months, fell by 4.2 percentage points to 24.9%. This is a five-week low. Pessimism is below its historical average of 30.5% for the 12th time in the past 14 weeks.

At its current level, neutral sentiment is back at an unusually high level, albeit barely so. The cutoff between a typical and unusually high reading is 40.0% (one standard deviation above average).

Many—but not all—individual investors anticipate continued volatility and/or think that the current political backdrop could have a further impact on the stock market. Trade policy is influencing some individual investors’ sentiment as well. While many approve of the Federal Reserve’s plan to continue gradually raising interest rates, some AAII members are concerned about the impact that rising rates will have. Also influencing sentiment are valuations, tax cuts, earnings growth and economic growth.

This week’s special question asked AAII members for their perception of the current state of the housing market. Nearly one out of three respondents (32%) describe housing as lacking enough inventory (especially for entry-level homes) or otherwise being too expensive. An additional 18% say prices are at risk of declining, with rising interest rates cited as a primary catalyst. Approximately 11% described the current environment as a seller’s market, while nearly 19% think the housing market will remain strong.

Here is a sampling of the responses:

  • “Tight with low availability, especially for first-time buyers.”
  • “Bubble developing. Too little inventory and rising interest rates spell trouble.”
  • “It appears to be a seller’s market with prices increasing.”
  • “A bit overpriced, but likely to stay that way.”
  • “As long as interest rates don’t spike, housing will remain strong.”

This week’s Sentiment Survey results:

Bullish: 34.7%, down 8.4 points
Neutral: 40.4%, up 12.6 points
Bearish: 24.9%, down 4.2 points

Historical averages:

Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!