6th February 2008
Why should you keep some of your investments liquid?
It's only natural to want to make sure all your money is working for you and earning the best return it can. But you need to balance this with the need to keep some cash spare in case of an emergency, or even so that you will be able to take up other investment opportunities, without delay, if they should arise.
If you are still working, ideally, you should have the equivalent of about three month's pay sitting around in cash. But if that sounds too ambitious, even one month's pay will do.
Most retirees on the other hand should normally have a minimum of 5% of their portfolio or 1 year expenses in cash. If you are waiting to take advantage of a new investment opportunity - but are just waiting for the right one - chances are you could have a lot more than that in cash reserves.
But don't have too much in cash. After tax and inflation, cash will not keep it's purchasing power over time. This is the big paradox for the risk averse. They think they will avoid the risk of losing their money by staying in Cash and Fixed Interest but, because all their returns are in income it is all subject to income tax rather than having part of their returns in growth enjoying the lower tax impost of the CGT regime.
So after tax and inflation the real value (to-days purchasing power compared to tomorrow's) of their portfolio suffers losses over time. Even the risk averse should accept some moderate risk if they want to avoid losing the purchasing power of their investments.
Most people would probably keep spare cash in their bank account. It's easy, it's already there, and there is no messing about. But although official interest rates are hovering around the 7% p.a. mark, earnings on traditional bank accounts - at around 0.05% p.a. for amounts less than $50,000 - just don't make the grade.
But there are alternatives. The good news is that wanting to keep some cash on hand doesn't have to mean you will need to sacrifice returns.
How can you make the most of your liquid assets?
If you want to earn more than 0.05% p.a. on the thousands or even tens of thousands of dollars you want to keep liquid, the most obvious alternative for many people will be a term deposit.
It is a fairly straightforward deal. In exchange for your agreement to lock your money away for a set period of time, you can earn significantly more interest than a normal deposit account.
Term deposit terms cover the gamut, and the term you choose will affect your return. As an example only:
- $1000 on deposit for 90 days can earn you 4.75% p.a.
* This increases to 4.95% p.a. if you are prepared to put it away for three years.
* The rate is 5.15% p.a. for five years. And if you have a higher balance it will pay even more.
- If you had, say, $25,000:
* You can earn 4.85% p.a. by locking it away for 90 days.
* Over three years you are looking at 5.20% p.a..
* It is 6% p.a. over five years.
While there are probably better things you can do with your money over a five or three year period, the shorter term deposit rates are well worth considering if you want an easy, hassle free way to make the most from your cash.
Cash Management Accounts (CMAs)
Although an easy option, term deposits are not the only alternative, and neither are they an optimal solution, particularly if you want to be able to access your money without locking it away.
If this sounds like you, you may be a candidate for a cash management trust, or account. Quite simply, a CMA is a managed fund. Like other managed funds the idea is:
- You pool your money with that of other investors
- A professional money manager looks after it in order to ensure you receive a good return.
- Because they are managing a much larger sum of money than you could ever acquire under your own steam, the theory is that they get access to better rates.
- As professional money managers, they know where to go to secure the best deals.
At the moment CMAs are returning around 5.84% p.a. but it's worth shopping around. At the time of writing returns across the major providers varied from 3.70% to 6.28% p.a..
It's worth remembering though that despite the fact that most CMAs are very safe, usually with AA+ ratings, higher returns usually mean higher risks. It may pay to look at the investment policy of CMAs that offer returns significantly above competitors' rates.
And with many of the features and services on offer, they can be a real alternative to a bank account, even for managing your everyday money. Many come equipped with linked chequebooks and credit cards, and have ATM access along with BPay and phone and internet banking facilities. Instead of being charged a monthly fee, all managed funds incur a so-called annual management fee. In the case of a cash management trust this is usually a little over 1% p.a. of the amount invested. So if you had $5000, over a 12-month period it would end up costing you a little over $50.
CMAs usually come with a minimum investment amount of $1000 or $5000, although it does vary from fund to fund. It's worth noting that if you are interested in putting a little money aside each week or month, to save for another purpose, some CMAs also offer a regular savings plan option where $100 a month can be deposited.
Another alternative, this time one of a managed fund variety, is to invest in a mortgage trust. Like a CMA, a mortgage trust is a vehicle that lets you pool your money with that of other investors. Instead of investing in cash, the manager will invest in mortgages.
It's worth noting that this investment isn't as safe as a CMA type investment - there is always the chance that there will be a default on the mortgage - but the trade off is you earn higher interest. This makes sense. You will know from the interest rate that you pay on your own home loan that mortgage rates are significantly higher than the rates being paid on cash in bank accounts. Most mortgage managers invest in commercial, retail and industrial property.
Obviously a mortgage trust or fund is not the one that you should consider for really short term money. If you are saving with a three to five year time horizon, which puts growth investments out of the picture, a mortgage trust Fund can be a good alternative.
A warning should be noted that small, badly run or dishonestly managed mortgage trusts can be very risky investments. Remember Estate Mortgage, in which investors lost hundreds of millions of dollars, was a mortgage trust which had been lauded in the media as "Funds Manager of the Year" not long before it went belly up.
However don't forget your house. Instead of investing in a mortgage trust, an easier alternative is to invest in your own mortgage by making additional repayments or using a redraw account. By putting money in your loan account:
- It reduces the money owing on your home loan and reduces the amount of interest you pay.
- Because the money is going towards reducing your debt - rather than paying you an income - you don't pay tax on it either.
- It means you are effectively earning a tax free interest rate that is equivalent to your mortgage rate.
- What's more, the money is available to you when ever you need it if your account has redraw ability.
8. Points to remember
- Always keep a cash reserve of at least one month and preferably three months pay.
- Don't put your cash into an ordinary bank account. There is always a better alternative.
- You don't have to put all your money in the one place but can spread it around depending on when you think you might need it.
- For smaller amounts of money a CMA type account maybe a better option.
- Whatever your final choice, shop around to compare the fees and charges. There can be large variations even on similar products.
- Make sure you choose an account that calculates interest daily. That way if your balance fluctuates, you will still be making the most of your funds.
- Don't forget your own mortgage. Additional repayments and using the redraw account can be an easy, safe and high yielding alternative.
- As a general rule, a higher return means you are taking on a higher risk.
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Head of Funds Management
t +61 3 8610 2811
Chris Andrews is the Head of Funds Management for the La Trobe Group and has responsibility for the La Trobe Australian Mortgage Fund.
Read full profile here.
La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 115 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.
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