Economist David Ranson asks a question we all want answered. What can we use as an alternative to cash? Listen to his answer.
The question comes up because it is punishing to hold the instruments that investors call cash or cash equivalents— Treasury bills, money in savings accounts and bank certificates of deposit.
Inflation is low, but the yield on this kind of holding is still lower. It’s practically non-existent. The yield on a 6-month Treasury bill is 0.08 percent. Invest $1 million and your yield for a year will be a whopping $800.
The source of the problem is ZIRP, the Zero Interest Rate Policy of our Federal Reserve. Because of that policy the asset that has been convenient and preferred by savers, retirees and near-retirees for decades is becoming the financial equivalent of your father’s Oldsmobile.
Hold it and you get no return. Invest in something else and you risk major loss.
Ranson believes there is an alternative. “It’s more feasible than I thought two years ago,” he said in a recent interview. He would not be surprised, he added, if we saw financial institutions putting together combinations of assets that will serve as cash substitutes.
And what could that be?
The answer, he says, has been called “the all-weather portfolio.” The idea can be traced back five centuries to Jacob Fugger the Rich. Fugger was a Renaissance merchant. He believed assets needed to be invested in four different things: stocks, real estate, bonds, and gold. Since they tended to move in opposition to each other, one would be rising when another was sinking. Long term, wealth and purchasing power would grow.
If they are put together in the right proportions, Ranson says, you can have an investment that has a higher return than contemporary cash, but less volatility— more stability.
If the idea sounds familiar, it is. The late Libertarian newsletter writer Harry Browne fostered it through his Permanent Portfolio mutual fund that holds investments in gold, cash, bonds and stocks. That fund, unfortunately, falls short on the stability requirement. A more recent advocate is Ray Dalio, founder of Bridgewater Associates, a hedge fund firm.
The big question is how to combine these opposing assets to get the stability of cash. That’s where Mr. Ranson has done some interesting research. Using his own formula to optimize the four asset classes, he found that these assets were actually more stable than cash— provided that you had a four-year perspective rather than a one-year perspective.
In the time period from 1969 to the present, he found that Treasury bills delivered a compound annualized return of 5.2 percent with an annual volatility of 3.3 percent. Measured the same way; his optimized asset mix provided an annualized return of 9.8 percent with an annual volatility of 7.6 percent. That’s not as stable as Treasury bills, even if the return was higher.
But if you measured the annualized volatility of four-year returns, the optimized portfolio had volatility of only 2.7 percent compared to 4-year volatility of Treasury bills, which declined to 3.1 percent. Part of the stability question is a matter of perspective.
Will we have this “new cash” sometime soon? I don’t know. But if your first thought is that it will never happen, let me remind you of a little bit of history.
Throughout the rising inflation of the 1960s, Regulation Q prevented small savers from getting market returns. The Federal Reserve rule raised the minimum investment in Treasury bills to $10,000. The rule worked to keep small savers in thrift banks where interest rates were lower. Basically, the rule penalized the small saver, but made banking safe for bankers.
Then, in 1971, two innovators created the first money market mutual fund. The fund allowed small savers to invest in a mutual fund that held Treasury bills and commercial paper. The funds became a new form of transactionable cash. The innovation created an entirely new mutual fund category. In June 1977 the regulators threw in the towel. They ended Regulation Q. Thrift bank interest rates were then tied to open market Treasury bill rates.
The current situation puts a greater burden on savers than Regulation Q. So it may only be a matter of time before a new financial innovation will allow us to by-pass cash.