As far as mutual funds go, the Cash and Cash Equivalent asset class has got to be the most unattractive for many investors. It lacks the wild swings that the specialized, small cap funds enjoy, it doesn’t even have the high yield that a lot of dividend funds can brag about and, well, it’s cash. Can anything cool be said about cash? Well, no, not really. But investors need to care about cash equivalent funds. Here is why:

• The obvious. Cash equivalent mutual funds generally do not depreciate in value. Their benefit comes neither from price fluctuations and volatility nor from interest earned, but from liquidity and safety. When Warren Buffet managed to stash away over $86 Billion during the market downturn of 2008, he was not whining about a lack of interest being paid on those funds. Instead, he knew that unlike his equity investments in the companies he felt had great long term capital growth prospect, he could draw on his cash reserves whenever he wanted… it would always be there waiting for him.
• Cash equivalent funds need not be “boring.” Since investors should always have a minimum of 5% invested in cash (even our most aggressive Asset Allocation Model recommends a minimum of 5% in Cash and Cash Equivalent Funds), it makes sense to explore a little. This means taking on a little more risk if such a position fits your investor profile. Some alternatives to straight Money Market funds, for example, could be Vanguard’s Short-Term Bond Index fund. This fund invests primarily in US Treasuries, yet its yield is actually 2.64%. Not bad for a bond index fund and given its short-term nature, even mild fluctuations are not something one can expect. And with $16.5 Billion under management, it seems to me that Vanguard will not have trouble meeting your redemption request. Plus, this fund in particular has never seen its value deteriorate over the course of a 12-month period. In other words, even if you were to experience a temporary pull back in this fund, simply holding on for a few more months will return any losses. By adding a bit of spice to your Cash portfolio, you can actually enjoy the benefits of Cash liquidity and safety and take advantage of bond-like and dividend-caliber yields.
• Cash is a perfect place to park funds earned on gains. Let’s face it. Markets rise and they fall. When one crystallizes gains on equity funds or even bond funds, logic often leads folks back into the same asset class from which they are exiting. This makes absolutely no sense! If you were to pull out of an equity fund because it returned a hefty 30% over, say 3 months, why jump back into equities? If equities were expected to keep rising, why pull out at all? The idea is to hold onto one’s gains and if core- and high-yield bond funds do not offer the promise of a good return, then why no park those funds in Cash? Looking back at Warren Buffett, that is exactly what he did. He did not simply wake up one day with $86 Billion in cash; he built those reserves, trimming gains as he went along during the market expansion period. This reserve allowed him to invest in companies he believed would have great prospects for gains, like Burlington North Railway.

Now it is true that Cash Equivalent Mutual funds are not hot and sexy. Even the Vanguard Short-Term Bond Index fund quoted here has little to offer in the sex-appeal department, and that fund is considered above-average risk among its category! In fact, this fund’s 52 week range is a narrow $10.17 to $10.56. So if it is not yet clear why you should care about Cash Equivalent Mutual Funds, just think of Warren Buffett and ask yourself what he might add to the three bullet points above. Most investors will realize rather quickly that Cash really is an important element to a successful investment portfolio. Sexy or not.

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