Where to stash the cash you're pulling out of stocks
We know many savers who've had it with Wall Street's relentless volatility and are pulling their money out of stocks.
But what should risk-averse readers do with all the cash they're accumulating?
The combination of historically low interest rates and flat-line inflation has made it almost impossible to earn a reasonable return of even 2% or 3%.
"I've never seen anything like it," says Bill DeRoche, the chief executive of FFCM, a Boston-based investment advisory firm. "It's a very, very challenging environment."
Paul Jacobs, client service manager at Palisades Hudson Financial Group in Atlanta, says, "It's difficult to get more than a percentage point or so on your cash without taking some real risk."
We ran some options by these two seasoned investment advisers to see where they think investors with a lot of cash on their hands should turn.
Certificates of deposit
If your goal is to protect your principal at all costs, there's still no better place to turn than a government-insured bank account.
Our database is a great place to compare the best CD rates from scores of banks.
But it's ugly in there right now.
You've just got to decide if the safety and stability are worth the pathetic returns.
Money market funds
A money market fund is a low-risk mutual fund that invests in safe bets like government securities, CDs, commercial company stocks and other low-risk securities.
Investment advisers have always recommended keeping a portion of your portfolio in money market funds for liquidity.
In this environment, is it wise to dial up that position?
"Your yield is going to be near zero," says DeRoche. "On the plus side, there is no cost to add or subtract to the fund and very little risk of a loss of principal."
Jacobs is equally unenthusiastic.
"It's not the layup it was 10 years ago where, if you had cash lying around, you'd just put it in a money market fund," he says. "The yield there is still extremely low, and you do have more risk than if you were to put it in an FDIC-insured account like a CD."
Short-term bond funds
In previous financial storms, one would typically seek safe harbor in bonds.
The problem this time is, with interest rates at rock-bottom and nowhere to go but up, locking into even short-term bonds can be risky because their price will fall when rates go up.
"Normally I'd like them, but the yields are just so low," says Jacobs. "Because it's short-term, you have much less risk than long term, so if you're looking to get involved in fixed income, I would definitely point you to a shorter-term fund."
If you're bond-minded, DeRoche recommends the Vanguard Short-Term Tax-Exempt Fund.
"This invests in bonds that have maturities of approximately one year, and the yield on the fund is about 1% that is tax-exempt, so compared to taxable bonds, that can be an attractive yield," he says.
Treasury Inflation-Protected Securities (TIPS)
Treasury Inflation-Protected Securities, or TIPS, are a low-risk, government-backed security designed to protect investors from the ravages of inflation.
Given that inflation is expected to rise in the coming years, TIPS should be a good investment, right?
Well, maybe. DeRoche says shelter-seeking investors with visions of double-digit inflation just around the corner have driven the price up on TIPS.
"The real yields on short-term TIPS right now are showing negative, so if you were to buy a very short-term TIPS, you could actually lose money," he says.
Jacobs says if you're a TIPS fan, go long.
"Longer-term TIPS are more attractive because you have positive real yields and you also get the rate of inflation as part of your return," he says. "Very short TIPS aren't very attractive at this time."
Floating rate funds
Floating rate funds, which expose mutual fund investors to bank loans and historically have acted as a hedge against inflation, have been all the rage lately.
But there's a steep downside to this move, because their performance depends on interest rates falling, not rising.
"This is not the appropriate place to stash your cash," Jacobs says.
"This fund can be a lot more volatile than your average bond fund and move more in line with the stock market. With interest rates so low that they have nowhere to go but up, if they do, most traditional bonds will lose value."
Market-neutral exchange traded funds (ETFs)
Exchange traded funds, or ETFs, track an index and trade like a stock, hence their name.
A relatively new version of these popular funds, termed market-neutral, uses the sophisticated quantitative investment strategies of hedge funds to insulate investors from market volatility.
While it's not without risks, moving some of your growth investments into a market-neutral ETF might calm some of the volatility in your portfolio today.
DeRoche's firm recently introduced seven market-neutral funds.
The fees run below many mutual funds, and unlike the hedge funds that corporations employ, ETFs are registered with the Securities and Exchange Commission, making them a much safer (and affordable) bet.
"Three of our funds have volatility that is two-thirds to three-fourths of the overall market," he says. "Since it has such a low correlation with the market, it provides a significant diversifier. You can really reduce the volatility of your holdings."