Wealth advisors often tell their clients to keep a certain proportion of their portfolio in CASH. Although the long-term returns on most cash investments are minimal (and, with inflation taken into account, they can be negative in real terms), they are beneficial because they dampen a portfolio’s volatility. But investors can now manage and invest their cash more effectively.

The question one must ask themselves is, “How much readily available cash do I actually need?” because daily liquidity comes at a cost. To reduce this cost, investors can put their cash into a number of instruments, from very safe MONEY MARKET FUNDS to products that behave like SHORT-TERM BOND FUNDS.

Slightly more risky than both of these is a new breed of instrument known as ENHANCED CASH PRODUCTS (ECP’S) also called ENHANCED YIELD, CASH-PLUS, or LIBOR-PLUS.

These products invest in a wider range of securities than MONEY MARKET FUNDS, and therefore offer a higher return. Most providers package them as MUTUAL FUNDS, although some offer them on a separate account basis.

These products became popular during the recent low interest rate environment. In 2002, the FEDERAL RESERVE lowered rates to 1% and left it there for a while, which really got the whole ENHANCED CASH market going. Institutional investors were the first to use ECP’S, but wealthy private investors have also found them advantageous.

ECP’S outperform MONEY MARKET FUNDS by taking modest amounts of interest rate, credit, and liquidity risk in the FIXED-INCOME MARKETS. In essence, the investor is giving up daily liquidity for a little more total return. The investor is picking up the benefits of higher yields by going a little lower in quality and a little longer on maturity.

Let me explain the differences between ECP’S and MONEY MARKET FUNDS:

MONEY MARKET FUNDS are governed by SEC rule 2a-7. This restricts them to short-term government securities, certificates of deposit and corporate commercial paper with a maturation timeline of less than 13 months.

The funds must maintain a constant NET ASSET VALUE (NAV) of $1 per share-for every dollar an investor puts in, the investor receives a single share in return.

 THIS RATIO CANNOT CHANGE!!!

Duration is also a difference between MONEY MARKET FUNDS and ECP’S. This is the weighted average time to maturity of a bond’s cash flows; more importantly, it signals the price sensitivity of an issue to a change in interest rates. Usually, the lower the duration, the lower the risk. MONEY MARKET FUNDS generally have interest rate durations of up to three months. Some conservative ECP’S have a duration close to this, but, for the most part, theirs tends to be between six months and one year.

ECP’S have an advantage over MONEY MARKET FUNDS because there is far less demand for the instruments they invest in. There are many more MUTUAL FUNDS chasing very short dated instruments.

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Because there are no legally binding regulations governing ECP’S, investors should proceed with caution. Investors have to be careful that they do not end up buying what amounts to be a short term bond fund marketed as an ECP.

The key is to look at the NAV. If it is a $10 NAV, then the investor can consider it an ultra short bond fund.

Investors should also confirm that the ECP manager only buys high-quality debt.

Investors should determine their liquidity needs before buying one of these products. ECP should be able to liquidate a position relatively quickly, perhaps within days. But ECP’S that do not have a $1 NAV may suffer short-term volatility, which could result in a short-term paper loss.

If investors do not need check writing and debit card access to their cash, ECP’S may be the way to go. However, if investors expect that they will need access to their cash within a year, traditional MONEY MARKETS are a better choice. The investor really should have a holding period of about six to nine months for cash. If you own ECP’S for less than six months, you could lose money.

If you have any questions and/or require assistance, simply…

ASK THE WIZ!!!

Even the best run companies can become overvalued. This often occurs when a company’s stock price has gotten ahead of its fundamentals (for more information about stock fundamentals, see the WIZ DAILY JOURNAL archives). The following four signs can help you determine whether a stock is potentially overvalued.

1)      When a stock’s PRICE-EARNINGS RATIO (P/E) is significantly higher than its 5 year average, the P/E is likely to contract toward the historical average.

2)      Another indication that a stock may be overvalued is when the upside-downside (US/DS) ratio, a way of measuring risk and return, is less than 1-to-1. This simply means that the risk of losing money is equal to or less than the chance that the stock will increase.

3)      The third indicator that a stock is overvalued is when its projected total rate of return is unacceptable. If a company’s annual sales are $600 MILLION USD or less the company is considered “small” and the desired rate of growth should be greater than 15%. If a company’s annual sales are $600 MILLION USD to $6 BILLION USD the company is considered “medium” and the desired rate of growth should be 10% to 15%. If a company’s annual sales are $6 BILLION USD or more the company is considered “large” and the desired rate of growth should be 7% to 10%.

4)      If the projected return does not match the desired rate of growth than the stock may be overvalued. The point to keep in mind is that small companies generally are riskier investments than large ones, thus you want a higher growth rate for a small company to compensate for the increased risk.

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If you have only high return stocks in your portfolio, you may be assuming too much risk. A better alternative would be to have a portfolio of stocks with a variety of returns, all averaging out to a desirable 15%.

By using the analytic formulas outlined above, you will be able to pick stocks and adjust your portfolio in a manner that will increase your positive yields.

If you have any questions and/or require assistance, simply…

ASK THE WIZ!!!

A report released today (May 14, 2008) indicated that inflation pressures eased a bit in April. However, food prices increased by the largest margin in 18 years!!!

According to the LABOR DEPARTMENT, consumer prices edged up 0.2% last month (April), compared to a 0.3% rise in March. Concurrently food cost jump 0.9% as prices climbed for many basic items such as bread, milk, coffee, and fresh fruits.

So far this year (2008) overall inflation is rising at an annual rate of 3%, down from a 4.1% increase for all of 2007. CORE INFLATION, excluding energy and food, is up at an annual rate of 1.8% in the first four months of 2008, compared with a 2.4% increase for all of 2007.

The rise in food costs was led by a 3.2% jump in fresh fruit prices. The cost of bread was up 1.5%, 14.1% higher than a year ago, while milk prices rose by 0.9%, up 13.5% from a year ago.

Clothing prices rose by 0.5% in April, even though discount stores reportedly engaged in heavy discounting in an effort to spur lagging sales. Gasoline prices were 20.9% higher than a year ago.

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Even with the slowdown in price increases so far this year, another critical factor that you must acknowledge is that, workers’ wages are not keeping up. A separate LABOR DEPARTMENT report revealed that average weekly earnings for non-supervisory workers dropped by 1% in April compared with a year ago, after adjusting for inflation. It was the seventh straight month that inflation adjusted wages were down compared to a year ago.

The combination of rising food and energy cost, weak wage gains, and falling home prices have left households feeling squeezed, with consumer confidence readings plunging to recessionary levels.

If you have any questions and/or require assistance, simply…

ASK THE WIZ!!!

Many employees are finding out that the managers of their 401(k) accounts are not doing a good job.

A recent study and analysis of nearly 1 million retirement portfolios revealed that 69% have inappropriate risk or diversification of holdings and 36% have worrisome concentrations of company stock. In addition, one-third of savers are not putting enough aside to qualify for the full company matching contribution.

The problems are especially pronounced among young and low-paid workers. Unfortunately those that need their 401(k) the most look to be benefiting the least. Some of the performance problems should dissipate as companies adopt automatic enrollment programs for workers, as authorized by the PENSION PROTECTION ACT two years ago.

The recent study found that when looking at risk and diversification of investments, 38% of the portfolios had very inefficient or very inappropriate investments. That could range from a young participant with a portfolio that is too conservative to an older worker with a portfolio that is too aggressive. An additional 31% had somewhat inefficient or risk-inappropriate holdings. The remaining 32% had good balance in their portfolios.

On the level of savings, the study found that just 7% of 401(k) participants were saving the maximum allowed. Nearly two-thirds of those earning less than $25,000 a year do not contribute enough to get the full company match, the study found. However, 24% of those earning $50,000 to $75,000 a year and 12% of those earning more than $100,000 a year did not get the full match, either.

The study was performed by FINANCIAL ENGINES, a Palo Alto, California based firm that provides investment advice and managed accounts for defined contribution plans like 401(k) s.

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Investment mistakes can be costly. For instance, a well balanced portfolio of $30,000 can grow to $74,315 over the next 20 years, even if there were no further contributions, while a poorly constructed portfolio would only yield $57,857, according to FINANCIAL ENGINES.

Some of the diversification problems stem from concentrated holdings of company stock. I have spoken about this numerous times on my radio broadcast (ASK THE WIZ, each TUESDAY & THURSDAY, from 2-4pm(EST), on www.WIGOAM.com).

Experts urge savers to hold no more than 10 to 15% of their accounts in company stock, pointing out that they could easily sustain significant losses if the company runs into trouble or goes bankrupt, a la ENRON, WORLD COM, and EASTERN AIRLINES.

The study by FINANCIAL ENGINES found that among savers eligible to receive company stock, more than one-third had more than 20% of their holdings in company’s shares. Some older workers had more than half their holdings in company stock, and workers with salaries under $25,000 also held a disproportionate amount of company stock.

Remember what Grandmamma always said: “Never put all your eggs in one basket.”

If you have any questions and/or require assistance, simply…

ASK THE WIZ!!!

Investment “experts” are often eager to advise investors about a “hot sector”, the best strategy might be to ignore it. Analysts and fund companies like to advise investors to “overweight tech” or “underweight energy”.

In plain English, that means they are saying to put extra cash into technology shares or less cash into energy stocks. If the economy is heading for a rough patch, for instance, it is time to buy “defensive” stocks; if the economy is pulling itself out of the doldrums, it is time to buy “early cyclicals.”  

The problem with well-worn ideas in financial markets is they tend to stop working and that often occurs with “sector pickers.” Lately, the difference between the “best” and “worst” performing sectors has not been nearly as stark as it used to be.

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Within each sector the differences between the best and worst performing stocks have not changed much over the past several years. Of course trends can and do reverse. The bottom line is, fund managers should worry less about picking “hot sectors” and spend more time picking “great companies.”

If you have any questions and/or require assistance, simply…

ASK THE WIZ!!!