Changes in Markets Make Holding Cash More Important than Ever

Changes in Markets Make Holding Cash More Important than Ever

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Low interest rates on bank products make it tempting to move money out. Here's why that might not be a good idea.

As interest rates on bank products have continued to fall, it has become increasingly tempting for investors to cut the cash portion of their portfolio. But an article from Morningstar provides a reason why such a move would be a mistake. The article, entitled A Market Lacking Diversification, explains how nine of eleven asset indexes analyzed by the author Abraham Bailin have become increasingly correlated from 2002 to today. The two outliers that didn't show increasing correlation were weighted heavily with Treasury bonds.

What does this mean?

For an investor, it means that diversifying a portfolio has gotten harder than ever. Diversifying means allocating money so that if one asset falls, the other goes up -  or at least doesn't fall. The idea is not to have all of your eggs in one basket. Correlation measures how closely different assets move in relation to one another. So, if the S&P 500 drops, a closely correlated index would also drop by a similar amount. To diversity a portfolio, you want correlations that are as low as possible or negative. Otherwise, when one market goes down, all of your other investments will also drop with it.

Note: A correlation number of 1 means that something perfectly mimicks the indicator it is being compared to. The closer to 1, the stronger the correlation.

Putting money into Real Estate Investment Trusts (REITs) or commodities used to be one way to diversity. Today, REITS have a .91 correlation to the S&P 500 while commodities have a .46 correlation, up from 0 ten years ago.

Why is Correlation Increasing?

Mr. Bailin hypothesizes that correlations have increased because of the growing importance of the risk on/risk off sentiment. Since the crash in 2008, investors view the market through a risk prism. When risk is perceived as low, they buy up assets that are considered more speculative. When risk is high, money flows out of these assets and into less speculative investments. Less speculative investments, like Treasuries happen to have a negative correlation to more risk based assets in the other indexes.

He also believes that correlation is increasing because more markets and indexes are being made in different asset classes. Ten years ago, trading in commodities was tiny. As more investors have piled in, the commodity index has come to reflect the sentiments of the general market.

The Growing Importance of Cash

Because cash is FDIC insured, it is the least risky of all asset classes. It also has a correlation of 0 to all other assets. Its value does not move in relation to any investment index. Therefore, if the rest of an investor's portfolio is getting increasingly correlated, it makes sense to hold cash, or to even increase the amount of money deposited into the bank. This is a phenomon we notice on BestCashCow. When there is a particularly bad day in the market, we see spikes in traffic as more investors look to protect their cash in insured banks and credit unions. As correlation has increased, it becomes even more important to place money in non-correlated holdings. An investor could put cash into Treasuries as another way to diversity their portfolio, but there is great risk in this. With interest rates so low, rates will eventually go up. When they go, Treasuries will lose value (Treasury prices move inversely to yield). It can be argued that at that point, Treasuries and the stock market will become more tightly correlated since rising rates will hurt Treasury prices as well as stock prices.

The Impact of Correlation on Your Interest Rate

Many investors already intuitively know this. Banks now hold record amounts of cash in the form of savings, CDs, and checking account. Even with the low rates, investors are parking a significant amount of money in cash. The irony is that the flight to safety has helped to bring down savings rates and CD rates. Many investors though, view banks as a safe place to park the safer portion of their portfolio until the world economy stabilizes. Any return is a bonus.

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Weekly Rate Update - Aflac Federal Credit Union Offering 2.41% APY Savings Account

Weekly Rate Update - Aflac Federal Credit Union Offering 2.41% APY Savings Account

Rate information contained on this page may have changed. Please find latest savings rates.

Aflac Federal Credit Union is offering a 2.41% APY savings account for its members, and that's no quack.

Work for Aflac? If so, don't overlook one of the perks of the job. Aflac Federal Credit Union is offering a 2.41% APY savings account for its members, and that's no quack. The average national savings account rate for local banks is 0.21% while for online banks it is 0.80%. That gives you a sense of how competitive this rate is. The rate holds for deposits up to $100,000.01. The rate on deposits over this limit drops to 1.10% APY which is still highly competitive.

Like most credit unions, Aflac has a restricted field of membership. That means not everyone can join the credit union and open an account. To quality for membership, you must be an employee of Aflac, or the spouse of an empolyee. If you qualify, you can call them and request a membership packet. The packet also contains instructions for how to open a savings account.

Aflac is a medium sized credit union with $168 million in assets. It has a Texas Ratio of 15.14%, which is higher than the national average of 10.34% but not high enough to be a big concern. It is NCUA insured, and is located in Columbus, GA.

Our weekly update came out a few day late this week because of the holiday. I'll be back to the normal Monday schedule after the New Year. Happy New Year and here's to higher deposit rates in 2012 (although I think we may have to wait until 2013).

Look for the best savings account rates in your area by clicking the "Savings" tab above.

Previous Weekly Rate Deals

Check back next Monday for a new bank deal. Email any deals you know about to ratedeal (at) bestcashcow.com. Feel free to also share them below. If you're a bank and have a great deal not listed on BestCashCow, register for access and add the deal to the site.


$250 and More in Bonuses from ING Direct's Black Friday Sale

$250 and More in Bonuses from ING Direct's Black Friday Sale

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ING Direct is back with their annual Black Friday sales event. As part of this event, ING offerering over $250 in bonuses to consumers who open certain accounts.

ING Direct is back with their annual Black Friday sales event. As part of this event, ING offerering over $250 in bonuses to consumers who open certain accounts. This year, the bonuses are as follows:

  1. $107 Electric Orange account opening bonus
    • Open Electric Orange November 25th - 27th and make a total of 5 purchases (either signature or PIN-based) using your Electric Orange Card or Person2Person Payments (or any combination of the two) within 45 days.
    • Your $107 bonus will be automatically deposited into your account on day 50.
    • Bonus only available for new Electric Orange checking. Only one bonus will be provided per household.
  2. $27 Kids Savings Account opening bonus
    • Open a Kids Savings Account November 25th - 27th and receive a $27 bonus into your new account. Only available when you open a new account with at least one new Customer (either you or the kiddo must be a new Customer to ING DIRECT).
    • $27 bonus starts earning interest upon account opening, and is available for withdrawal after 30 days.
    • There's no minimum deposit amount required. 0.90% Variable Annual Percentage Yield effective as of 10/21/2011.
  3. $32 MONEY account opening bonus
    • Open MONEY November 25th - 27th and make 1 Card transaction (either signature, PIN-based or with PayPassTM) using your MONEY Card within 30 days and you'll receive a $32 bonus into your new account. (Keep in mind, the teen gets the Card.)
    • Your $32 bonus will be automatically deposited into your account on day 35.
    • There's no minimum deposit amount required. 0.25% Variable Annual Percentage Yield effective as of 7/13/2011.
  4. $100 401K Roll Over
    • Roll over your 401K with a Sharebuilder IRA and get $100.
    • Roll over or transfer in a qualified retirement account of at least $5,000 before 12/31/11 and you’ll receive a $100 bonus by January 16, 2012. Transfers from ING DIRECT, fsb and affiliates do not qualify. The bonus will count towards your 2012 contribution limit and will be reported on your Form 5498.

These bonuses last 3 days from Friday , Nov 25, 12:01am ET - Sunday, Nov 27, 11:59pm ET.

More on these and othe bonuses from ING Direct.

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