Advisers need to get their clients back in the game

Despite double-digit unemployment, big deficits and a raft of other looming concerns, the economy isn’t bad enough to justify the more than $9 trillion sitting on the sidelines in various low-yielding bank instruments.

For financial advisers, that huge amount of money doesn’t just represent lost investment yield but also lost opportunities for both their clients and their businesses.

A year ago, when things really looked bad, there was about $8 trillion on the sidelines, and the year before that, when most people didn’t yet realize how bad things could get, the figure was about $7 trillion. Both are huge figures, but at least there was some semblance of yield to help justify the allocation to cash.

That isn’t the case today.

After two major stock market meltdowns in the span of 10 years, investors are more skittish than ever, but in the financial advice business, cash isn’t king.

It isn’t logical that barely yielding money market funds and certificates of deposit should continue to hold such overwhelming appeal in the wake of historic rallies by virtually everything that isn’t cash.

“It’s amazing how many people are willing to earn zero to protect their capital,” said Cathy Roy, chief investment officer of fixed income at Calvert Investment Management Co. Inc.

Even more amazing is how many financial professionals are willing to let people earn zero.

There will always be tactical and strategic reasons to hold some cash as part of an overall investment strategy, but the idea of cash as an investment strategy has taken a turn for the ridiculous.

The most recent data from the Federal Deposit Insurance Corp. shows that during the first nine months of 2009, all bank deposits grew by $65 billion, to $9.1 trillion, but a sub-category of less liquid term deposits such as CDs declined by $278 billion, to $2.3 trillion.

This means that for every dollar added to the overall pool of cash, almost $5 was moving out of the less liquid but highest-yielding subcategory of those cash instruments.

“This is an indication of an uneasy feeling about the economic recovery and inflation,” said Dan Geller, who analyzed the FDIC data as executive vice president at Market Rates Insight. “People are realizing that if they lock their money up they don’t have the flexibility to pull it out if they need to protect themselves against inflation.”

It’s a solid tactical strategy — until you consider the fact that the total cash pile has continued to swell throughout one of the most impressive market rallies in history.

One effort to fight the tide is being deployed by Sam Jones, president of All Season Financial Advisors Inc.

Having watched clients transfer money to CDs in 2002 and then never return to the market, he created his own cash “holding tank” that uses mutual funds and exchange-traded funds to manage a strategy that he calls a “two out of 10 on the risk scale.”

“We wanted to give people who are afraid of the stock market a place to go that’s not away from us,” Mr. Jones said.

The holding tank, which currently accounts for about $2.5 million of the firm’s $100 million under management, has generated an annualized return of 3.6% from August 2005 through last month.

This compares with a 3.2% return over the same period by the Vanguard Money Market Reserves Fund (VMFXX).

However, over its trailing 12-month period, the holding tank was up 3.5% last month, compared with a 0.2% gain for the benchmark.

About half the holding-tank portfolio is allocated to municipal bond funds, and the balance is spread over senior floating-rate notes, high-quality corporate bonds and short-term Treasury bonds.

In some respects, the holding tank’s recent performance turned out to be a bonus, because the ultimate objective is to keep clients from missing opportunities by clinging to cash.

“For most investors, being afraid of the market is temporary,” Mr. Jones said. “But what they’re really scared to death of is outliving their money.”

Mr. Jones doesn’t charge a fee on the assets in the holding tank. “It usually only takes a one-finger push” when it comes to convincing clients to get back in the market, he said.

Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected].