The Importance of Cash in an Investment Portfolio

A diversified portfolio typically includes a cash component to it, and this cash holding provides an investor with liquidity and convenience. Traditional portfolio theory suggests that investors should carry some static percentage of their portfolio in cash to act as a diversifier against volatility in one’s portfolio, for liquidity purposes to add to one’s existing bond or equity positions, or fund new purchases.

While cash in a savings account, bonds, GICs, and others, have usually offered lower yields than the returns that can be found in the stock market, the benefit that the liquidity and stability cash offers can sometimes outweigh the benefit from the higher returns that stocks offer.

Traditional Vehicles of Yield

For the past couple of decades, strong sources of yield have been few and far between, but the most common vehicles of yield for investors have been:

• Bonds
• GICs
• Savings and High-Interest Savings Accounts
• REITs

Each serves its own purpose and has its own place within a portfolio, but these represent common sources of yield in the world of investing. All the above-listed vehicles are dependent on interest rates. The higher the Central Bank raises its interest rate, the more attractive the yields are on bonds, GICs, high-interest savings accounts, and even REITs (although more indirectly).

The surge in central bank interest rates over the past year has rippled through to yield-generating investment products and has created a resurgence in the want for yield and stability in a portfolio. This is where high-interest savings ETFs play a role. These are relatively new investment products that have filled a need for providing investors with liquidity, stability, attractive yield, and minimum limitations.

The Pros and Cons of Each Yield-Generating Product

Earlier, we talked about the main sources for yield in an investors’ portfolio, but now we want to compare how they stack up in terms of liquidity, ease of access, and any limitations. In the table below, we have analyzed the relative yields, price stability, investment limitations, and fees associated with each product.

Source: 5i Research

We can see that GICs offer an investor with the highest source of yield, but the main drawdown compared to a high-interest savings ETF is that they require an investor to lock in their cash for a predetermined amount of time.

High-interest savings accounts through financial institutions can offer competitive sources of yield and offer an individual with price stability, although they often carry requirements for holding a minimum balance in the account or a minimum investment amount and may have monthly account fees.

REITs provide investors with modest yield, but they are highly sensitive to changes in interest rates and the price instability can at times offset any benefits from their yields.

Bonds have been a historically safe approach to earning yield while offering some level of price stability, although, their prices are negatively impacted by sudden changes in the interest rate, and this year is particularly evident of this dynamic.

High-interest savings ETFs, we feel, offer a good combination of all factors, providing an attractive yield with high price stability, and no minimum investment or lock-up periods.

The Bottom Line for High-Interest Savings ETFs

High-interest savings ETFs are a safe and effective method of attaining high yield in an investor’s portfolio. While they do not have as attractive rates as GICs do, their benefit of price stability, no minimum investment or lock-up period requirements, and reasonable management fees make them a great option for an investor seeking yield. Overall, we think the entrance of high-interest savings ETFs into the Canadian space is a net positive for an investor's portfolio and can help to minimize volatility and maximize yield.

Research for Today, Invest for Tomorrow.

 @5iChris