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How Low Can They Go? Earn More on Your Cash.

According to the Wall Street Journal, Americans are holding nearly $7.5 trillion in cash (banks accounts and money market). If you’re like most investors today, you are fed up with the measly interest rates offered by bank saving accounts and are desperately looking for ways to maximize your returns. According to bankrate.com, the average bank savings account pays a paltry 0.22 percent; that’s $22 for every $10,000! As a result, investors are forced to take greater risk for higher yields or alternatively, continue to watch their savings erode with the passage of time. Fortunately, there are some ways to enhance the return on your cash without significantly increasing risk.

Luckily, inflation is nowhere in sight, and some economists are even predicting deflation. But while economists argue about which will come first, inflation or deflation, you want to get the best rate on your cash now. Historically, investors have used laddered CDs (buying CDs with different maturities), individual bonds, money market or savings accounts, or a combination to earn higher rates, but these methods have proven unsuccessful in this low-rate environment. However, there is good news for those of you starving for higher returns on your cash… Exchange Traded Funds (ETFs).

Before you consider investing in ETFs, it is important to determine what kind of cash saver you are. Savers of cash fall into two general categories: those holding cash for a rainy day, and those saving for a specific purpose such as a down payment on a house. If you are saving cash for a specific and impending purpose, your best option is to accept the low bank rates to maintain FDIC insurance, avoid investment/principal risk, and ensure that your cash is liquid for when you find the house of your dreams. However, if you are saving cash for a rainy-day, have no immediate need for short-term liquidity, and would like to enhance your returns, an ETF portfolio may be a better option.

Rather than parking your cash in a savings account, one option may be to consider investing a portion of cash in both the Vanguard Short-Term Bond ETF (BSV) and the SPDR Barclays Capital High Yield Bond ETF (JNK). For example, by using just 20 percent of your total cash and investing 15 percent of it into BSV and 5 percent of it into JNK, your 1 year return would have been 1.97 percent. Alternatively, if you split the 20 percent cash evenly between BSV and JNK, while still keeping 80 percent of your total cash in a low paying savings account, you could have increased your 1 year return to 2.75 percent. The immediate assumption is that junk bonds are high risk and are not suitable for someone interested in parking their cash. However, a well diversified junk bond ETF, combined with a short-term bond fund, and a large allocation to cash will enhance returns without significantly increasing portfolio risk. See chart below for allocations discussed above.

Source: Yahoo Finance Cash 80% Cash15% BSV

5% JNK

80% Cash10% BSV

10% JNK

1 Year 0.22% 1.97% 2.75%
Year to Date (7/31/2010) 0.22% 0.70% 0.64%

If absolute financial safety is more important than slightly higher interest, then you should keep your cash in an FDIC insured bank account. However, if you are parking your cash for an emergency or just to maintain liquidity, and you’re willing to take on some risk then there is no reason why you can’t diversify your cash among several return enhancing assets, such as ETFs.

Ara Oghoorian, CFA is the president and founder of ACap Asset Management, Inc., a “Fee-Only” financial advisory and investment management firm located in Los Angeles, CA. Ara can be reached at aoghoorian@acapam.com or at http://www.acapam.com