Most people should start with a high quality Treasury Money Market Fund for their cash. This is what Browne advised for the standard portfolio. The only mod I’ve made is once you get enough cash for a year or so of living expenses then you can consider (optionally) to use a Short Term Treasury Bond fund. This will give you slightly better returns for only a small amount of interest rate risk. The cash in the Treasury Money Market Fund can tide you over if interest rates spike so you can ride out the relatively small losses you’d see in the ST Bond fund.

I wouldn’t use a broker’s MMF unless they are offering a 100% Treasury Money Market Fund. I’ve never seen a brokerage sweep MMF fund yet that is 100% Treasury bills. Maybe they are out there, but I get the feeling you’d have to set it up yourself to be that way (that’s what I had to do). They won’t do it by default. Banks use a Money Market Account which is different than a Money Market Fund as many are FDIC insured. Yet, I’d still prefer a Treasury MMF above them as well.

In 2008 some very large money market funds got into big trouble and broke the buck due to the credit crisis. Other short term non-treasury funds lost tremendous amounts of money (some lost over 1/3rd if I recall taking on risky bets). Only a Treasury Money Market fund has the liquidity and safety you want for your cash. I implore you not to take credit risk with your bonds and cash. It just isn’t worth the risk. Just seek out Treasuries.

Bank CDs are backed by the FDIC. I’m not sure the FDIC is terribly solvent. It’s certainly realistic to expect the Treasury would continue to back the FDIC if they continue to deplete their reserves, but in a very severe crisis who knows what would happen? You also need to be sure you don’t exceed FDIC limits or you can get into trouble during a bank close. With a Treasury MMF there is no limit. If you own Treasuries, then you are fully covered by the Full Faith and Credit of the US Treasury.

Ultimately, the cash you want in a very safe vehicle and you just kind of have to accept that at times it is a lost opportunity if some other asset is doing very well and you could have bought it. But other times the cash is the only buffer you have in the portfolio if your other assets are doing poorly and you don’t want to be in a situation where it is at risk.

Lastly, just remember that if a bank is offering a high interest rate it could be because the bank is in trouble and trying to coax in new customer capital to shore up their books. While the theory is if they go bust the FDIC swoops in to take care of you, why take the chance on being the first test case when things don’t go according to plan? In terms of the total portfolio, the extra return would probably amount to less than 1% a year. Just doesn’t seem like a good bet to me. Don’t get into the trap of chasing yield. Investors get so busy chasing yield that they often run themselves right off a cliff.

If you want to wager for higher returns, it’s a better bet to just risk it on stocks for speculative purposes. Doing so only with variable portfolio money you can afford to lose of course.

I have a question about the cash allocation. You’ve mentioned a number of funds, short-term bill and treasury market, to use. Is there much difference between them? How do ETFs like SHV and BIL compare to, say, your broker’s or bank’s MMF, or a high-interest bank account or CD ladder?

Thanks for your help!

-Chris

Best,
Ray

I really think that portfolios that hold stocks and bonds only are broken. I wouldn’t dream of not holding gold and cash along with my stocks and bonds. I talk with people that think the 25% allocations to gold and cash are too high. Yet, I always encourage them to at least hold some meaningful amount of these two assets along with stocks and bonds at all times to get better diversification.

The 2000s are wrapping up and the stock market for the decade was basically flat to slightly negative real returns. This is the second time this has happened in the last 40 years (happened in the 1970s). That’s a 50% failure rate for the stock heavy/bond approach over this time period in my view. Yet, there are those that criticize the Permanent Portfolio approach of holding cash and gold (horrors!) when it has never turned in a negative 10 year period of real returns. Most of the time it’s in the 3-5% after inflation return range. That’s something a stock/bond portfolio could never claim.

I think the “stocks and bonds are all you need” portfolio theory is wrong. You need to own some assets that have fundamentally different economic drivers behind them than stocks and bonds to get diversification.